Fed Policy

March 03, 2013

Weighing the Week Ahead: Is There a Stop Sign at the Old Market Top?

There is a psychological barrier at market tops. Think about this conundrum:

By definition, a former top failed. That is how it got to be a top!
A new high is the most bullish thing a market can do. Also by definition, since going higher means reaching and taking out old tops.

As market averages approach old highs it becomes a great story for financial media. It can be played either way – A or B. It is such a natural that I expect it to be a dominant theme next week, despite the important employment news.

For story "A" feel free to do a Google search for "lofty levels" or the like, perhaps including the name of a popular pundit. Alternatively, you can search for "double top" or "triple top."

For story 'B" we find those whose business success is firmly aligned with the success of their investors – independent financial advisors. Josh Brown is a leading advocate for this group and he does a nice job analyzing a complex story. Ned Davis Research looks at past occasions when the market revisits prior highs. Mark Hulbert reports the story. Hulbert gets featured on CNBC. Everyone involved acknowledges that there are only 13 prior cases, so we should not make much of this.

And then we do.

Josh has exactly the right touch, navigating between data analysis and a few anecdotes. He is not wildly bullish, but he understands that a little data can be a helpful antidote to misleading headlines. Here are the past occasions from Ned Davis:

Even allowing for the small number of cases, the result is encouraging.

I have some further thoughts about the new high which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog . There is a nice combination of data, speeches, and other events.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

This was a pretty good week for economic data. There was bad news, but mostly with a political angle.

The State Department report on the Keystone Pipeline found few problems. Advancing the pipeline is a market-friendly event.
Homeowners are getting above water. Zillow reports that underwater borrowers have declined by two million in the last year. The CoreLogic numbers are a little lower.
Business investment is stronger. This is a crucial factor, given the strong corporate balance sheets and the pre-election jitters. Dr. Ed writes as follows:

I was certainly pleased by the underlying strength of January's durable goods orders excluding the volatile transportation index. It suggests that companies did curtail their capital spending plans late last year as a result of fiscal cliff fears. I argued that too many investors were focusing on the downside of going over the cliff and ignoring the upside if the cliff was averted, as we expected.

US oil production hits a new high. Ultimately this will be a positive for the trade balance, GDP, and fuel prices, but it is a work in progress. Here is the dramatic chart from Mark Perry:

Michigan sentiment was even higher than the preliminary estimate. Doug Short has good analysis and a fine chart.
The ISM index beat expectations. The results are consistent with GDP growth of about 3.7%, although recent readings have seemed to over-state the relationship from the ISM historical data. Most of the underlying components were also solid.
Bernanke's Congressional testimony clarifies and emphasizes the Fed commitment to monetary stimulus. Markets rallied, but many pundits are more interested in arguing their personal viewpoints about the Fed instead of accepting and profiting from the reality. (Here's how).

The Bad

It was a tough week for the world's leading democracies and their leaders. There was also some soft data.

Personal income dropped dramatically. See Steven Hansen at GEI for a full analysis and some interesting charts.
The Italian election. The immediate market reaction was very negative. The hot money follows simple rules. This looked like the return of an old story – one which had major effects in the past. After the recent stock market advances, many were looking for a reason to sell. The story deserves deeper analysis. My own current conclusion is that it is yet another installment in the ongoing negotiations. It is a process of democracy, which Mark Mazower calls a "political meltdown." Those of us who are more comfortable with democracy might see this as a healthy push back against austerity. The Economist offers this take:

"Italy's political convulsions underline the need for Mrs Merkel to adapt her prescription. So far it has been a lot of austerity and some reform; it should be the other way round."

Whatever your political viewpoint, this is not a signal of imminent Eurozone collapse, dominoes, cockroaches or whatever, or an instant impact on US stocks. I am watching the yield on Italian and Spanish bonds, which moved higher and then pulled back – not at a danger level.
Spanish GDP is looking ugly (via Bonddad).

Sequestration began with far-reaching implications if an agreement is not reached soon. Most often trumpeted is the overall macro effect of a reduction of GDP in the range of 0.5 to 1%. One important illustration is the effect on domestic energy production. Here is the report from the Oil & Energy Insider, which also has several other timely and helpful stories.

"Outgoing Interior Secretary Ken Salazar told industry leaders on 26 February that "the potentially devastating impact of budget reductions under sequestration could slow our economy and hurt energy sector workers and businesses."

For fossil fuels, it doesn't look good, either: The immediate effect will be a delay in the development of oil and gas projects on federal lands due to program cuts at the Department of the Interior. According to Salazar, we're talking about 300 fewer onshore oil and gas leases issued in western states, and delays for some of the 550 offshore oil and gas projects in the Gulf of Mexico."
Gas prices were up six cents a gallon last week. But there is hope. The EIA expects prices to fall later this year. And the Senate is going to investigate the "unreasonable increase" in gasoline prices during the past year. Thank goodness for that!

The Ugly

Prospects for compromise on deficit reduction. These headlines from The Hill tell the story:

Boehner says no new taxes after sequester meeting in White House

Pelosi: No budget deal without new revenues

'I am not a dictator,' Obama says

Unlike past political "deadline events," I did not forecast an eleventh-hour solution for this one. The immediate consequences are important, but not catastrophic. The long-term consequences of a deal are important. All parties have a current incentive geared to these interests rather than a fast solution.

So we should not expect a fast answer. I think that we will get one in a month or two – a good subject for a full-length analysis. Unlike some others, I avoid speculation in the absence of solid information. We'll know more soon.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

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

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators. I will try to do a more complete review soon. Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

The year-end effect of the fiscal cliff debate on real income is apparent, as is the resumption of the payroll tax.

The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data were expensive for many. The reason that I track this weekly is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

Employment situation report (F). This is always the most important data for markets.
Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
ADP private employment (W). This has been as good as the "official" numbers.

The "B List" includes the following:

ISM service index (T). Especially watch the employment component.
The Beige Book (W). Anecdotal evidence that provides color for the next FOMC meeting.
Trade balance (Th). Worth watching for overall trends (especially in energy) and also the GDP effect.
Factory orders (W). Older data, but still a significant factor.

There will be continuing news about the Italians efforts to form a new government. While all of the major news organizations are giving the story great attention, I especially like the Italian election coverage from Ft.com. I understand the modern mantra that "information wants to be free." If you want the best content, you sometimes need to support the publisher financially. I purchase a subscription from The FT and the WSJ (among others that I often mention) for this reason.

Trading Time Frame

Felix was marginally bullish last week. [I missed my regular weekly posting. For those who want a complete history, please check here.] We actually reduced trading positions to 2/3. This week's further decline in the ratings has moved Felix's forecast to neutral and we are only 1/3 invested for trading accounts. This could change very quickly. At the moment, it is more likely to shift to bearish than back to positive.

One of the things that Felix does best is controlling risk. Even when Felix delivers only normal market returns, the result is accomplished with less risk.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

Buying in times of fear is easy to say, but so difficult to implement. Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

This week's Barron's has a cover story describing how the big-time wealth managers are recommending a shift from bonds to stocks.

"The world hasn't collapsed, and there's a beginning of a normalization in the way we look at the markets," says Chris Wolfe, chief investment officer at Merrill Lynch Wealth Management.

Go ahead and read the Barron's story. Please compare this to my 2013 preview for Seeking Alpha. This covers the same theme along with some other key catalysts. There are also some specific stock and sector ideas. My recommendations did well last year, and we are off to another good start. You need to be comfortable in taking the other side of one of the most hated rallies in history.

But please beware! General ideas are not for everyone. Each person needs unique treatment. We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options.

Final Thought

Should we be worried about the new market top?

I recently suggested that investors are too easily victimized by the media focus on fear. Many have missed a nice market move (so far) by following those who offered headlines without data. There is an infinite supply of headlines!

It is a sad irony that our intelligence and reading – skills that work so well on most fronts – fail us so badly when it comes to investment decisions. The intelligent investor will always find persuasive things to worry about.

Abnormal Returns, everyone's choice for the leading curator of financial stories, noted that I was not alone on this theme. Tadas has an excellent story, with great quotations from Barry Ritholtz, Josh Brown, and Seth Godin. Pulling together these stories is both rare and helpful, so please take a look. It is also one of many important themes from his book (recommended here).

We are all suggesting, in slightly different ways, that the best investment choices require more than simply following the list of worries from financial media.

March 03, 2013 in Contrarian Investing, Europe, Fed Policy, Individual Investors, Markets, The Week Ahead, Trading | Permalink | Comments (0) | TrackBack (0)

January 10, 2013

Business Cycle Forecasting: The First-Rate Results of Robert F. Dieli

This article is probably the most exhaustive and challenging piece I have written. It was worth the effort because understanding the business cycle is crucial to making great investment decisions. To get the full benefit, I urge readers to spend some time reading the background links and watching the videos.

I am going to follow up with another piece describing how I use this information for investment decisions. For now, let us all focus on the method, understanding how and why it has worked so well throughout history.

Background

In May of 2011 I embarked on a search for the best recession forecasting methods. I had been a long-time fan of the ECRI approach. They were still very positive on the economy at the time, and my quest was not driven by their conclusions. I was uncomfortable with the methodology and the lack of transparency. I had many reader suggestions, and I reviewed them all. The criteria were stringent -- "Jeff's Acid Test." The easy winner of this competition was Robert F. Dieli's "Mr. Model." (This article described the competition and the results).

The main conclusion from Bob's work was that there was no imminent recession. This ran counter to some other well-publicized and popular forecasts. Some readers complained in the comments that the history of the forecast included some imperfections. Others disagreed with the methods. The subject was too difficult for simple responses to these questions. I promised to follow up in more detail, but I wanted to do so in a convincing fashion.

A Year Later

A year later, some key elements of my rationale should be even more convincing:

Bob was right -- once again, as so many times before. And he did it in real time, not on a back-tested basis.
Imperfections in real-time forecasting are acceptable -- even desirable. When I see a perfect forecast, it always means that the model has been tweaked and changed to fit all of the past data.
Simple is good. Methods that over-specify the number of variables and numerical trigger points also imply excessive back-fitting and poor predictability.
Theory is important. The model should make sense.

Most recession forecasting models fail because they emphasize weakness. This is backwards. A recession begins at a business cycle peak, something that I explain more carefully here. A recession starts with excessive strength. Seen any of that lately?

Dr. Dieli explains this quite clearly in this chart.

Your intuition about the business cycle would be better if you completely forgot the "R" word and took Bob's lead: Substitute "business cycle peak."

The key driver of Bob's forecast is what he calls the "Aggregate Spread." By reviewing results over decades we can see that this method actually provides a warning of about nine months. The image below describes the composition of the spread, using example data from August.

The most recent aggregate spread is shown below. Just as it did last year, it provides strong evidence that the US economy is not nearing a recession.

And Now -- The Show

Get some popcorn and your favorite beverage and settle back to watch the show. I recently met with Bob Dieli to discuss economic forecasting and to create some videos. The result is an eight-part series in which we discuss each of the recessions of the latter 20th Century. [Thanks to Derek Miller for helping in the production of the videos and producing the key summaries.]

In this first video, Bob and I discuss National Bureau of Economic Research and why their definitions of a recession are important. The nonpartisan NBER looks at both the peaks and troughs of the business cycle to conclude when past recessions have happened, effectively making "autopsies, rather than forecasts" - as Bob says. Therefore, it is important for the Mr. Model to use the same criteria when it forecasts for recessions, providing a clearer picture than other models.

In part two, Bob and I take a close look at the recession of 1957. In doing so, they describe exactly how Mr. Model works. The model signals 9 months ahead that the business cycle will be heading towards a peak or trough when it crosses the 200 basis points (shown as a red line on the chart).

Bob and I illustrate the ways in which policymakers can and do impact the business cycle and how this interacts with Mr. Model. In the run up to 1960, tightening by the Federal Reserve as well as fiscal cuts by the Eisenhower Administration led to an economic downturn. In 1967, when the Fed again tightened the yield curve, the model signalled a recession. Shortly thereafter the Fed eased up, thereby avoiding a recession. At the end of the day, the NBER never called a recession in '67.

Mr. Model had nearly spotless performance in predicting the recessions of the 1970's. Contrary to popular belief, the 1973 recession had less to do with OPEC and more to do with other government policies that laid the foundation for an economic downturn.

Mr. Model shows the result of Fed Chairman Volker's monetary policy, which inverted the yield curve and brought the Fed funds rate to 20%. The result was a short 6-month recession, then a short recovery which was stifled by other policies. Interestingly enough, the recovery never took Mr. Model past 200 basis points - meaning a new peak could not have been established for the "second" recession.

After the "double dip" recession of the 80's, the recovery brought the business cycle to record highs. This led to the third-longest period of economic expansion into the summer of 1990. A combination of tightening monetary policy and changing policies regarding the first war in Iraq were both responsible in part for the downturn. In 2000, Mr. Model signaled a recession in an election year - something that was sure to happen regardless of who was elected. However, in both instances the model predicted short and shallow recessions unlike the seriousness of the early 80s.

In the most recent recession, Mr. Model's results were decidedly different than they had been for any previous recession. The model alerted that the 200 basis point line had been crossed in 2007 but did not decline sharply. This is in part because tightening by the Fed did not effect the yield curve as they had in past events. Quick reactions by the Bush and Obama administrations also helped to prevent a dramatic decline in Mr. Model's basis points.

In this final video, Bob and I focus heavily on the 2007-2009 recession. The model appears to show a false positive as it crosses the 200 basis point line in 2006, but continues sideways for some time before the recession was officially called. In a sense, this suggests severe instability rather than the dramatic declines of the past. In any case, we had ample warning that a recession was coming. It did not take us by surprise.

Conclusion

If you have studied the evidence, you will see that recessions usually involve the Fed!

You might also have noticed that business cycle peaks do not typically come from a problem of "stall speed" but one of excess stimulation.

Market observers are completely mistaken:

Wrong indicators;
Wrong interpretation (weakeness versus strength);
Wrong sources;
Wrong point of the business cycle; and finally
Wrong stocks.

These will be the subjects of the next installment.

January 10, 2013 in Fed Policy, Forecasting, Interpreting Data, Recession Series, Research Methods | Permalink | Comments (12) | TrackBack (0)

January 05, 2013

Weighing the Week Ahead: Are Earnings Expectations Too High?

The quirks of the calendar have delivered a week that has little fresh economic data. Some will use the quiet period to continue the discussion of politics and the debt ceiling. Others will focus on predictions for the coming year.

Most are tired of "the cliff" and will be happy to turn to a new subject: It's time for earnings!

This earnings season will be especially important. Here are two key reasons:

Forward earnings estimates are at an all-time high. The oft-repeated pundit opinion is that analyst estimates are excessive and must be reduced.
The January earnings season often includes full-year guidance. This is always interesting, but perhaps even more so right now.

Both of these intriguing ideas come from my Chicago-based friend Brian Gilmartin, who is among the very best sources on corporate earnings. He sees the forest, since he has tracked the ThomsonReuters estimates for over a decade. He notes trends in these estimates as well as revisions by sector, most recently with this report at his blog. He also covers many individual stocks through his posts on Seeking Alpha. (see his Alcoa preview).

I have some thoughts on this earnings season, which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The holiday-shortened week still had a lot of significant news, and it was mostly positive.

The Fiscal Cliff decision. Those who object to this being scored as "good" should re-read the criteria, e.g., market friendly. They also need to separate their political opinions from economic reality. The decision avoided an immediate economic drag from the expiration of tax cuts and the sequester. This was good for the economy and good for stocks. Those who are complaining the loudest about the outcome are the same people who were completely mistaken in their forecasts. I recommend that real investors ignore these sources and read my review of the outcome. There are obviously important remaining issues. I'll get around to those when it is more timely --- which is not right now!
The ISM index is back above 50. Bespoke has a good discussion of the trends in the sub components, including this chart:

The ISM services index was even better. See Steven Hansen's comprehensive discussion, including the various components.
Shadow home inventory is down 12% according to CoreLogic (via Calculated Risk).
Commercial lending is higher, along with many other growth indicators. Scott Grannis is not happy with the election result or current tax policy, but he is open-minded in looking at indicators. See the full article for all ten of his charts. Here is one example:

The technical picture is better with an upside-down head and shoulders playing out, among other patterns. The analysis is not that simple, and difficult to summarize. Charles Kirk's success reflects his willingness to change with the data. His site has a small charge which goes to charity after offsetting expenses, and it is well worth it. He provides this week's update while fighting the flu. Get well soon, Charles!
Europe continues to improve. Remember the threat of rates over 7% Dominoes falling? You can either listen to the words of those singing the same song, or you can look at data. Dr. Ed notes that the mission is being accomplished even without actual sovereign debt buying by the ECB.

The Bad

There was not much bad news last week. I invite readers to nominate items that I overlooked, but make sure that they are fresh -- not just stale and recycled opinions.

The FOMC minutes. These are usually not controversial, but the new era of transparency from the Fed seems to be backfiring. Despite the meeting decision to increase the QE program, to some the minutes seemed to suggest that a policy change might be imminent. This is a good topic for more work, so it is high on my agenda. Meanwhile, I recommend the comprehensive discussion from Cardiff Garcia at FT Alphaville -- a careful look at various perspectives. I also like the account from Paul Vigna at MarketBeat.

"Investors aren’t looking at the fundamentals through their own eyes, but through what they think the Fed thinks, and trying to gauge when the Fed will send a signal to everybody else that it’s going to change course. Because if you’re really playing this game, you’re trying to catch that signal from the Fed before every other trader, speculator and investor does."

Manufacturing new orders disappointed. See Steven Hansen's report for all details.

The Neutral

Employment. I do not do a neutral category very often. I want to mention the employment report, but I cannot bring myself to call it "good" in the current market context. It was certainly not "bad." The job growth is consistent with recent months, which means that it is positive, but far less than what is needed. The report avoided the customary complaints about seasonality, labor force participation, and manipulation of data.

We need businesses to start hiring more aggressively.

The Ugly

This week's ugly award goes to the "sold out bull." I tried to explain why those who missed the "fiscal cliff rally" should simply understand that it was not all about price --- it is a matter of risk and reward. If you choose to avoid the high-risk situation (and what turned out to be the best price), there is no shame in buying after the risk is lower. It can be quite smart, and more consistent with your objectives. Very few understand this concept.

Josh Brown is more expressive and colorful, and I recommend the full piece. As usual he absolutely nails the market psychology of those who have been left behind. We can all learn from this:

No, the sold-out bull is pure evil - ferociously outspoken or slyly suggestive, he is all the time engaged in a singular mission: Scaring others out of the investments that he would like to buy back himself at lower prices.

The sold-out bull is a sickly creature, a thrashing fish on the deck of a ship, out of its element and sucking at the air for one more breath. Every trick will be employed, from fiery sermons of impending doom to sarcastic asides about the dopiness of those who are still in.

The sold-out bull is desperate and his mind is twisted, every thought and expenditure of energy is employed toward the creation of a lower entry back into the markets. Only a cheaper buy-in will vindicate the earlier decision to sell that haunts him so.

Steer clear of the sold-out bull, for the ferocity of his bearishness comes from somewhere very dark and extremely cold. He will hurt you if he can, climb over your body to get back in.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest verdict is that the ECRI has flunked Recession 101! I have been expecting the ECRI to declare that their forecasted recession is over. The secret long-leading indicators have been identified by some, and they have improved since the original forecast.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. A month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved a bit over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure is moving higher, so we are becoming less confident in short-term trading.

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

The "B List" includes the following:

Trade balance (F). Continuing implications for the GDP.
The JOLTS report (Th). Mostly helps on the issues of structural unemployment and letting people see the gross job changes. Not much movement in recent months.

There are a number of Fed speeches on tap. Given last week's news, this may be more confusing than enlightening.

Most important is the start of earnings season.

Trading Time Frame

Felix has moved to a bullish posture, now fully reflected in trading accounts. It has been a close call for several weeks. Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Our current trading holdings have a foreign tilt.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

Even the pros get it wrong. Any of us who are constantly commenting on markets will have some bad calls, but last year was worse than usual. Bloomberg's Michael Patterson & Lu Wang write, Almost All of Wall Street Got 2012 Market Calls Wrong. Citing some of the most prominent forecasts, they write as follows:

All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.
The ill-timed advice shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”

“They paid too much attention to the fear du jour,” Jeffrey Saut, who helps oversee about $350 billion as the chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 2. “They were worrying about a dysfunctional government in the U.S. They were worried about the euro quake and the implosion of Greece and Portugal. Instead of looking at what’s going on around them, they were letting these macro events cause fear to creep into the equation.”

Final Thought

How can you go wrong by under-estimating Congress and other political leaders? Amazing!

But that is what happened. Even modest expectations for results was enough to keep you on the right side of the market.

For the upcoming earnings season I remain open-minded and I will be very attentive. Last quarter was a minefield for corporations. If the complete story -- earnings, revenue, outlook -- was not perfect, the stock price moved lower. I avoided earnings dates in our most aggressive trading programs, and I was nearly always right.

So what now? We all know that the economy remained sluggish in Q4, so earnings will not be great. Much of the uncertainty has been lifted. We know the election result and also tax policy for the near future. Will companies provide a little more guidance? What will it be?

I have more respect for the analyst updates than I do for the pontificating pundits with opinions but absolutely no record. I understand that analysts are too bullish in their multi-year forecasts -- basically following trends with no allowance for bad news. I also understand that by the time earnings are actually reported, the bar has been lowered so that more than 60% of companies beat expectations.

Most experts share these views, but I seem to be alone in drawing the logical conclusion:

If estimates are too bullish in the long run and too bearish at the time of the report, there must have been a "crossover date" when the forecasts were pretty good. My research shows that this occurs at about one year in advance.

To summarize: This earnings season will be important for estimate revisions as well as the current "beat rate."

January 05, 2013 in Contrarian Investing, Fed Policy, Government, Individual Investors, Interpreting Data, Markets, Politics, The Week Ahead, Trading | Permalink | Comments (2) | TrackBack (0)

December 15, 2012

Weighing the Week Ahead: Clarity Coming on Key Market Challenges?

After several weeks of noise -- from both data and politicians -- it may finally be time for some clarity. I have predicted this with my theme for the last few weeks, and we are starting to see the results:

The Fed -- aggressive policy, clearly stated, but still not well understood (more below).
US economic data -- the Sandy weakness is proving temporary.
China -- signs of an end to the slow slide, and not a hard landing.
Housing -- several signs of a bottom and some for a real bounce.
Europe -- none of the really bad things happening, but further delays in a final solution.
The fiscal cliff -- the biggest unresolved issue.

The problem with this list is that the fiscal cliff issues are so important that we really need some answers -- and soon! As I wrote in my first installment of "Cliff Notes," there has been little real information so far. I refuse to join in the daily discussion of non-events, but it will now start to get interesting. I will write more installments of Cliff Notes as circumstances warrant.

For the purpose of our weekly review, I will simplify this in two dimensions -- content and timing.

Content

Many issues have been lumped together as part of the Fiscal Cliff discussion, just as last year's debt ceiling debate turned a routine matter into a threat to US credibility. I am putting all of the issues into two categories

Tax matters -- Bush-era rates, AMT, doc fix, inheritance, capital gains, and dividends.
Long-term deficit issues -- Sequestration, entitlements, payroll tax "holiday," higher retirement age, higher Medicare age, and the like.

There are also issues concerning the renewal of long-term unemployment benefits and whether the debt ceiling will be a regular pinata for Congress. These might be taken up in either group. The first group is most important to the economy since it would have an immediate effect.

Timing

I have predicted that this issue would go to the last possible moment. How is that defined? I am reminded of my college days when I lived in Indiana. The State legislature was Constitutionally required to pass a budget by a certain date. Each year the legislative session ended, with no further options possible. They regularly missed the deadline, although they were always close. The Sergeant-at-Arms would go to the back of the chamber and stop the grandfather clock, halting it a little before midnight. Time stood still! Eventually the budget was passed, meeting the official deadline.

There are four possible deadlines to consider:

This week, allowing a Christmas break.
Before the end of the year.
In the first few days of the new Congressional session.
Weeks or months later.

The timing track for tax matters is more urgent than for deficit matters.

I'll offer my own take on what to expect on the fiscal cliff in the conclusion. Let us first do our regular review of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The economic news last week was mostly good.

Initial jobless claims dropped to 343K range. This was not quite as good as forecast by New Deal Democrat from The Bonddad Blog, whom we cited last week. He caught a mistake in his initial work and posted a very honorable correction. (It would be a better world if more bloggers caught their own mistakes and corrected them). As I noted last week, this is a very noisy series with many adjustments. It is great information, and I watch it closely.
The world will not be ending on Friday. The Mayans predicted 12/21/12 as the day. NASA says "no." From The Telegraph: In America Ron Hubbard, a manufacturer of hi-tech underground survival shelters, has seen his business explode. "We've gone from one a month to one a day," he said. "I don't have an opinion on the Mayan calendar but, when astrophysicists come to me, buy my shelters and tell me to be prepared for solar flares, radiation, EMPs (electromagnetic pulses) ... I'm going underground on the 19th and coming out on the 23rd. It's just in case anybody's right."

The Fed gets more aggressive, with pedal to the metal for a long time. Despite the ho-hum market reaction, this is market-friendly news. It is going to require more than I can do in the weekly summary, so here are two hints:
- This will increase the money supply, monitored weekly at The Bonddad Blog. Their weekly indicators are mostly positive, but those who are monetarists should be encouraged by the resumption of growth in real M2, now 5.6% year-over-year. This works with a lag on the economy, so we have not seen it yet. Read the full story to see the other high frequency indicators.
- Josh Brown jumps fast on the instant analysis of the punditry. Below is his chart, but you need to read the entire post (The Dumbest Thing You'll Hear...) to understand the message.

Industrial production bounced 1.1% in post-Sandy data. See Calculated Risk for details.
China's flash PMI moved nicely higher. See GEI for complete details and charts.
German investor confidence is "materially better" (via the Big Picture).
Inflation data of all types was benign.
The JOLTS report shows more job openings (good analysis from Steven Hansen).

The Bad

There was some bad news last week, but not very much.

Retail sales rebounded to a gain of 0.3%, a bit short of expectations.
Wholesale inventories increased 0.6%, a bit more than expectations. Inventories are a "fudge factor" for everyone. Increased inventory is great if it augurs a perceived future need. Inventory is not so good if unplanned.
Q4 earnings growth is still positive, but declining each week (via Bespoke).

The cliff diving odds increased to 75% according to one good source.
The small business optimism index plummets. This was planned as my highlight for the worst news of the week. Here (via Macroblog) is the key chart:

When you read the entire article, you understand that the story is mixed. The "young firms" are actually optimistic. A loyal reader also pointed me to this story, suggesting that the survey results might reflect partisanship more than business plans.

Regular readers know by now that I am trying to find evidence that will help us all in making the right news. I try to evaluate each piece of news. Small business is important for job growth. It is an interesting question. David Beckworth looks for the answer, leaning to the absence of demand rather than regulation, based mostly on this chart:

This is a great article, but you need to see the other charts to get a full understanding.

The Ugly

All of the other nominees for "ugly" were pushed aside by what happened to our kids in Connecticut. We parents understand instantly, but we are not alone. Events like this always focus attention on what to do. It is too soon to think about that.

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. Think of The Lone Ranger. (I was uncomfortable in even mentioning a bullet this week, but that is going too far. The Lone Ranger and his trappings are symbols of a better time and place -- one that we do not need to lose).

This week's award goes to Tom Brakke. He highlights a problem that I see every week. Someone sends me a chart which has been manipulated to fit a specific scale and time period. It looks compelling and powerful. It is dangerous. Here is Tom's candidate of the week, two ways of looking at Apple.

The full article is recommended, but here is the key quote:

"I have written before about the ease with which the producers of charts (including me) can deceive, even if not trying to do so. Some of the most common ways include picking a starting point for a chart that maximizes a particular point of view, using price instead of total return for longer periods, and putting lines together on a chart without comparing them on a percentage basis. Today’s topic is an example of the latter.

In a given day, you probably see lots of charts with multiple axes. Most all of them give you a distorted view of the world. You might get an idea that something is going up when something else is going up — and down when it is going down. That can be of interest, but multiple-axes charts, which are popular with investment professionals and bloggers, give false indications."

This is very strong work, mostly because the misleading techniques are so common. Whenever you see a chart like this you should be asking what it looks like in different time frames and scales.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Despite the recent media blitz from the ECRI, there is no evidence of an imminent recession concern.

Joining the discussion this week is University of Oregon economist and veteran Fed-watcher Tim Duy. Prof. Duy takes up all of the indicators and does a slam-dunk refutation of the ECRI.

"I think that even a cursory glance of all the data the NBER cites as elements in recession dating, even ignoring the important issue of first identifying broad-based indicators, would lead one to be very skeptical about a July recession call on the basis of "eyeball econometrics" alone."

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. He remains open-minded about the upcoming evidence. In the latest article, ECRI Weekly Update: Walking the Recession Plank he notes that the ECRI seems to have gone too far, "ECRI, however, has "walked the plank" with the company's recession call. And and at this point there's no "Peter Pan" recession to save them from a sea of crocodiles."

For the current time period to be viewed as the start of a recession, we would need to have a significant decline in the economy. Then the NBER goes back and dates the start of the recession at the last peak. As yet we have only small declines, and only in some indicators. None of the best methods I follow shows anything like this.

RecessionAlert uses a variety of different methods, including the ECRI, in developing a Super Index. They also offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. Dwaine Van Vuuren notes that the effects of Sandy have pushed industrial production into recession territory, sending the current chance of a recession over 11% according to one of his indicators. His latest article emphasizes his short-term indicators. He is not identifying a recession in any of the various covered time frames.

Georg Vrba explicitly and carefully refutes the ECRI approach. I encourage a thorough reading of Georg's work -- a few minutes well spent.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong. Newly added to the list of errors this week was the popular but bogus 100% recession chart. Amazingly, this is still getting buzz. Confirmation bias in action!

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. Two weeks ago we switched to a bullish position, and the outlook has become even more positive. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure has recently moved lower, so we are becoming more aggressive.

The Week Ahead

This week brings a lot of economic data, but not the most important reports.

The "A List" includes the following:

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. We will look for confirmation that the Sandy effects are over and seasonal adjustments have been reasonable.
Building Permits (W). This is the best leading indicator on housing.
Personal income and spending (F). I am promoting this to "A" status because of the bogus claims that a recession started in July. This is a factor to monitor.

The "B" List" includes these entries:

Housing starts (W). Lags permits, but still important.
Durable goods (F). A good post-Sandy read.
Michigan confidence (F). The preliminary reading was really bad.

We get the various regional Fed surveys which mean little for me. They are not important unless deviating dramatically from expectations. I also do not care about the final GDP revisions for a quarter in the rear-view mirror.

There will also be assorted Fed speeches, including one by Fisher (a leading hawk).

And most importantly -- Congress's decision on whether they want to take vacation for a week.

Trading Time Frame

Felix has moved to a more bullish posture, now fully reflected in trading accounts. It has been a close call for several weeks. Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have moved much higher in the last two weeks. We noted last week that we expected more buying, and that was what happened.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

This week I want to highlight Cullen Roche's article, The Bull Market in Fear. He captures the key point nicely in this comment:

"One thing I’ve really battled with in this industry (and in life) over the years is overcoming emotions. In particular, overcoming fear. If you have a portfolio you’re probably worried about something (to some degree). It’s natural. You’ve accumulated all this savings and you’re worried it might just disappear on a computer screen because of a few bad decisions."

This really captures the problem facing so many. Cullen goes on to illustrate the high levels of current fear, loosely correlated with past results. Even that has broken down.

Buying in times of fear is easy to say, but so difficult to implement. Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price!

Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out." This usually leads to mistakes in market timing. There are plenty of stocks at attractive values right now. Here is what to think about:

Risk. If you are like the average investor you have it all wrong. You have been piling into bonds, gold, and dividend funds. All of these categories are now over-valued, the result of this stampede. Some of the risk is showing up right now, and you will see more in the next few weeks.
A portfolio anchor. You need stability. If you are trying to do it with bond funds, you need to understand the risks. I prefer owning specific bonds.
Stretching yield. My approach is to find some reasonable dividend stocks and sell near-term calls against the positions. If you did this skillfully, you could hit double-digit annual returns with significantly less risk than simply owning dividend stocks. The range-bound market of the last few weeks has been ideal for this approach.
A little octane. Many investors do not think carefully about asset allocation. There is always volatility, so the key is to "right-size" your position. Instead of trying to time the market, try to be a player in the right sectors, the right stocks, and the right size. There are plenty of stocks selling cheaply in terms of their historic P/E multiples.

Final Thoughts on the Cliff

After weeks of no movement, this might now become a fast-breaking story. I'll do more Cliff Notes summaries as indicated.

So far the story has developed as I expected. Some are changing their odds since nothing has happened. This is fine for those following all of the commentary, but silly if you did not expect any action in the first place!

There has not been much polling of members or advance work --- "whipping" in Congressional parlance. This means little since positions are pretty well known on these issues.

My forecast calls for a resolution of the tax issues before any real economic impact occurs. Republican constituents are most dramatically affected by the AMT and the doc fix. Every poll shows that the GOP will be held accountable. Over 80% of Congressional insiders expect higher taxes on the rich in 2013. It is only a matter of when and how the tax policy will be changed. The publicized sticking point of rates for those with incomes over $250,000 is subject to compromise on the level of income, the exact rate, and adding some limits on deductions. Both sides can claim victory in a compromise.

If the GOP can bargain this for an attractive commitment on spending cuts, we could see something major before Friday. This would not include the "details" that everyone is foolishly discussing. Any agreement will involve guidelines with various Congressional committees to work out the implementation. For those who never took a class about Congress, think of it this way. Management is making some kind of across-the-board spending cut and looking to departments for specific proposals. This is a rough approximation for Congress. It could be stated more strongly since in this case the departments consist of various fiefdoms, all jealously protecting long-held power.

If there is nothing before Friday, we will see Congress in session for a final week of the year. No one wants this. The GOP might even vote "present" in the House to get the tax matters passed.

If the GOP cannot get an attractive deal on the deficit issues, those will be taken up next year with the debt ceiling as the key leverage point.

Investing Implication

Since opinion is widely divided on the fiscal cliff issues, the market should move significantly when we know the outcome. Much will depend on whether a two-part agreement (tax matters now, deficit matters soon) is effectively communicated.

It is also options expiration week, so things could get interesting.

December 15, 2012 in Current Affairs, Fed Policy, Government, Individual Investors, Interpreting Data, Markets, The Week Ahead, Trading | Permalink | Comments (0) | TrackBack (0)

December 08, 2012

Weighing the Week Ahead: Something New from the Fed?

As I wrote in my preview two weeks ago, we needed to expect a period with more noise than signal. The post-election posturing and the effects of Sandy have left investors with less real data than usual. In the next few weeks we may finally get some clarity.

This week may provide better policy definition from the Fed. Despite the Bernanke-era emphasis on policy transparency, the message from the Fed still seems far from clear.

Perhaps because it fits a convenient story, much financial commentary puts a strange twist on current policy. This was partly due to the election, where the Fed became an issue. This distraction for investors is over. It may now be easier to emphasize the facts.

Here are some common mistakes by the Fed punditry:

The Fed is out to punish cautious investors, pushing them into risky assets;
The Fed is targeting asset prices;
The Fed has engaged in boundless money printing;
The Fed is out of ammunition;
The Fed is watching each new release, prepared to change course.

These are all incorrect.

I'll offer my own take on what to expect from the Fed in the conclusion. Let us first do our regular review of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The economic news last week was mostly good.

Initial jobless claims returned to the 370K range. The news might be even better. New Deal Democrat from The Bonddad Blog did some great original research. He took the state-by-state data, dropped NY and NJ as a basic "Sandy adjustment" and came up with 339K! Read the full post. We'll all be watching the upcoming series closely.
Car Sales have been great. (via Scott Grannis).

Household wealth has rebounded. This is basically good news, as I show in the first chart from Scott Grannis. The second chart provides an inflation-adjusted historical context from Doug Short. Both perspectives are helpful. The nice improvement has not taken us back to pre-recession levels.

ISM Services Index is stronger. The services sector may be more important to watch. Check out the comprehensive analysis from Steven Hansen at GEI.
The Employment Report beat expectations (including mine). Most of us thought there would be more of a Sandy effect, but the official survey period for the establishment report seemed to miss the dates of the worst effects. There was more of an effect on the Household survey. The market applauded the overall job gain, but careful observers have some reservations. Prior month revisions reduced the gain closer to expectations. The decline in the unemployment rate was mostly due to people leaving the labor force. Bottom line: Jobs are growing at 150K a month, slower than the 200K or so at the start of the year. It is not a recession, but also not enough growth. Long-term employment is worse. One bright spot is improvement in state and local government trends. Reductions there have been subtracting jobs for several years. The private job growth has been closer to past recoveries. Calculated Risk shows the significance of this effect.

Greece is qualifying for the next round of aid. This includes writing down debt, a step toward returning to growth. The Euro-bears are in absolute denial about progress, refusing to look at data. Remember how they always cited the 7% rate on the ten-year as the trigger for contagion? How this was going to lead to tumbling dominoes? The rhetoric is still there, but the data are not providing any support. See the chart for Italy and Spain from Dr. Ed:

The Bad

There was some bad news last week, and some of it is important.

The ECB downgrades the European economic prospects, but keeps policy stable. (Via the FT.) Europe may not represent falling dominoes, but economic stability is at least a year away.
The ISM Manufacturing index dropped to 49.5. This is contraction in manufacturing, but not necessarily for overall GDP. The ISM cites the GDP break even point as 42.6, and usually provides an implied GDP figure, which I have always cited. It is pretty easy to reverse engineer their regression equation, and I have done so. This month they do not give an implied GDP growth rate. Others have suggested that the relationship has changed over time. For the moment, let us leave it this way: ISM manufacturing below 50 is still consistent with economic growth, probably in the 2% range or so. The ISM attributes weakness to concern over the fiscal cliff. (See here).
University of Michigan consumer sentiment plunged to 74.5. In the absence of any other bad news, this has to be attributed to the fiscal cliff and the non-stop media coverage. There is an element of self-fulfilling prophecy to this. Last year's debt ceiling debate did not result in default, but most people only noted the dysfunctional process. Until now, the average person has been willing to wait until after the election for a resolution to issues. This is the first sign of a change -- and it is important. Regular readers know that I love the Doug Short chart of this series, so let us look at the ugly update:

The Ugly

This week's ugly award goes to the worst-run companies of 2012, courtesy of Scott Rothbort. Scott has a passion for education, sharing his knowledge and expertise with Seton Hall students in addition to running his own investment firm. He is a colleague at Wall Street All Stars, where he writes a great daily market column, My Gut Feeling, which draws upon his extensive experience and finger on the pulse of the market. I do not want to slight any other colleagues, because it is a great group. We have a vibrant daily discussion of the market. (Email me if you want a trial or discount to the site).

Scott's choices are based upon sound criteria, and he shows prior membership from 2006. Great fun, and useful!

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Despite the recent media blitz from the ECRI, there is no evidence of an imminent recession concern.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug's latest commentary questions the ECRI definition of sales. He remains open-minded about the upcoming evidence.

Georg Vrba explicitly and carefully refutes the ECRI approach. I encourage a thorough reading of Georg's work -- a few minutes well spent.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we switched to a bullish position, but the forecast is still cloudy. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly last week. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure has moved to the very top of the range. This means that we do not have a lot of confidence in the current bullish rating, nor did we in the former bearish rating. It has been a close call over the last few weeks. "Abstain" might be more accurate.

The Week Ahead

This week brings some economic data, but not the most important reports.

The "A List" includes the following:

The FOMC decision (W) should provide confirmation of additional QE actions.
Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. We will look for confirmation that the Sandy effects are over.

The "B" List" includes these entries:

Retail sales (Th). One month will not tell the full story, but this is part of the recession analysis.
Industrial production (F). Same as for retail sales. I expect a pickup here, but the fiscal cliff uncertainty is a factor.
PPI (Th). Not a factor at the moment.
CPI (F). Also not a factor.

There will be continuing non-stop speculation, attempting to parse the words of anyone who will discuss the fiscal cliff. None of this will be very helpful. The progress is happening behind the scenes.

Trading Time Frame

Felix has moved to a more bullish posture, but it is not yet reflected in trading accounts. It has been a close call for several weeks. Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have moved much higher in the last two weeks. We are now completely flat in trading accounts, but expect to add positions this week.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

I want to emphasize that this is the approach I take for programs with a long-term orientation. It is entirely appropriate for long-term investors to buy when traders are selling. That is often when bargains are found. The smart alec's who call this "dumb money" should spend some time reading the wisdom of Warren Buffett. This is an important time for investors with long-term goals.

Risk. If you are like the average investor you have it all wrong. You have been piling into bonds, gold, and dividend funds. All of these categories are now over-valued, the result of this stampede. Some of the risk is showing up right now, and you will see more in the next few weeks.
A portfolio anchor. You need stability. If you are trying to do it with bond funds, you need to understand the risks. I prefer owning specific bonds.
Stretching yield. My approach is to find some reasonable dividend stocks and sell near-term calls against the positions. If you did this skillfully, you could hit double-digit annual returns with significantly less risk than simply owning dividend stocks. The range-bound market of the last few weeks has been ideal for this approach.
A little octane. Many investors do not think carefully about asset allocation. There is always volatility, so the key is to "right-size" your position. Instead of trying to time the market, try to be a player in the right sectors, the right stocks, and the right size. There are plenty of stocks selling cheaply in terms of their historic P/E multiples.

Final Thoughts on the Fed

I expect the Fed to replace "operation twist" with a new asset purchase policy, keeping the monthly target of $85 billion. That is only the start.

This week's FOMC meeting also comes with a press conference from Chairman Bernanke. The Fed's latest initiative, popularly dubbed QE3 or QE infinity, is designed to change market expectations.

It has not worked.

In fact, the Fed Chair's statements have actually fostered the misperceptions listed in the introduction. It is time for clarity instead of Fedspeak:

The Fed is encouraging businesses to make investments by reducing lending costs. The effect on individual savers is a side effect, not a goal;
The Fed is interested in asset prices only as an indicator of the economic effectiveness of the policies. The "wealth effect" is also a tertiary mechanism for transmitting policy effects. It would be better to quit mentioning these secondary points. Whenever they are cited, the financial media ignores everything else and pretends that this is the main theme;
The Fed has expanded the balance sheet, but the money supply has increased at a pace that is lower than the long-term average;
The Fed's policies take six months or longer to occur. Traders and pundits incorrectly over-estimated the first QE's and are now under-estimating this one.
The Fed is determined to change expectations, willing to accept more inflation, and geared to much lower unemployment. The individual data releases have little influence.

Since I do not have Bernanke's ear, I am not expecting more clarity. For those who understand Fed policy, this is an opportunity. If you do not wish to fight the Fed, the first step is to understand the policy. How else can you know what you are not fighting??

A Final Thought

The fiscal cliff participants continue to prove in public that they are bargaining hard. It does not matter that Congress took a long weekend. I am still hopeful for a pre-Christmas resolution on the tax issues with overall debt questions coming later. There will be some firm guidelines, but the opportunity for Congress to participate in the details.

The market gyrations will continue, but do not expect meaningful cliff news this week.

December 08, 2012 in Europe, Fed Policy, Individual Investors, Recession Series, The Week Ahead | Permalink | Comments (4) | TrackBack (0)

November 03, 2012

Weighing the Week Ahead: Approaching Dangerous Curves?

Crunch time!

Our decisions are always important, but this week could be special. I am giving it extra attention and extra work. I recommend that others do the same. It is not enough to passively watch the news. It means preparing for events! If you do not already have a solid position, you should be poised to react.

For several weeks there has been a sense of an impending inflection point. It is apparent in the technical analysis, with many indicators at key levels. It is obvious in sentiment. And it is obvious in the fundamental issues -- most significantly the fiscal cliff.

The political season has created deferred decisions. This has caused business leaders to defer risk. The cautious outlook from nearly every company reflects these concerns. Why not? Any executive who did not give some lip service to the litany of worries would seem pretty stupid.

Should we take this information at face value?

I'll offer my own take on these complex themes in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog. There is a nice combination of data, speeches, and earnings reports.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The economic news last week was mostly positive. Perhaps it is partly the political season, but there was a little bit of "yes, but" connected to each report.

Earnings. The earnings "beat rate" is improving as the season progresses. This is an improvement over the recent pattern, and on a pace to better than last three quarters. (But we know expectations were lowered). Bespoke has the story and a great chart.

The Chinese economy, as measured by the "official PMI" is improving. Kate Mackenzie at FT Alphaville explains that it is really a mixed picture.
Consumer confidence from the Conference Board is stronger. At face value, this means a reflection of better current conditions and employment. Doug Short has the "yes, but" in his thoughtful post and great chart.

Payroll employment grew significantly. The "yes, but" is that the overall rate of growth is still disappointing. Calculated Risk has a measured and thoughtful assessment, with plenty of charts. Derek Thompson suggests that the report is better than the headline, since the revisions imply a gain of 255,000 net jobs gained. The pace of gains in the last three months is much better, as you can see from his chart:

ISM manufacturing was in growth mode and better than expected. It is consistent with economic growth of 3.1% based on ISM research. Steven Hansen at GEI has a thoughtful look at the index and the various components -- well worth reading.

The Bad

The actual data last week was pretty good, but the stock result was bad. This happens, and it can be meaningful. Let us take a closer look.

The revenue "beat rate" remains terrible. This chart from Derek Thompson at The Atlantic tells the story by sector:

The European economy weakens further, as measured by the PMI reports (via FT Alphaville).
Employment disappointments included no improvement in hours worked (which trades off freely with new jobs at a rate of 330K jobs per hour or so), in hourly wages, or in long-term unemployment. These are all significant elements of the complex employment story.
Light vehicle sales, while up from last year were down from last month. (Via Calculated Risk).
Sandy costs. These are now in the $50B range and mounting. Various pundits are speculating (in both directions) about the impact on GDP and economic growth. It is far too soon for this kind of discussion. It is a negative on all fronts.

The Ugly

The US electoral process. It has worked for centuries, but it seems to be broken. The campaigns are now paying about $1000 per head to reach the undecided voters in a few states. The voters sought are the least educated and least informed. They claim to hate negative advertising. In actuality, research shows that the negative ads swing them. If you are a voter in my state (Illinois), your presidential vote does not matter. Will this discourage people from participating? Other races are still important.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. Bob and I met this week, planning an update soon after the election. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. The most recent news from the ECRI states that they are "Assessing the Current Optimism." This is apparently available only to paid subscribers, the ones who had early access to the 2011 forecast.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we shifted to a bearish position, but it was a pretty close call. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings have continued to drift lower. The penalty box percentage measures our confidence in the forecast. That indicator has moved to the top of the range, indicating little confidence in the current bearish rating. It has been a close call over the last few weeks.

The Week Ahead

This week brings very little economic data.

The "A List" includes the following:

The election (T). For investors, it is not merely about the Presidential election, but the shape of Congress.
Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

The "B" List" includes these entries:

Michigan Sentiment (F). A good read on employment and current conditions.
ISM services index (M). The service sector has become more important than manufacturing. This series does not have the long history of the ISM, but is gaining more attention.
Trade balance (Th). Important for the GDP and overall economic health.

There will also be many more earnings reports from a wider variety of sectors. We will probably also see (after a refreshing interlude) some Europe stories.

Nothing will match the election analysis, with investor implications for the fiscal cliff, taxes, economic growth, and specific stocks.

Trading Time Frame

Felix has shifted to a bearish posture. It has been a close call for several weeks, but it is now turning more negative. Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have moved lower again this week. We are 1/3 invested in an inverse ETF for trading accounts, and another 1/3 would not be surprising.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance. Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Investors often let the calendar tell them when to review. I recommend taking a look this week. Here is what to think about:

Risk. If you are like the average investor you have it all wrong. You have been piling into bonds, gold, and dividend funds. All of these categories are now over-valued, the result of this stampede. Barron's featured the dividend funds on the cover. Josh Brown had an instant reaction, saving me the job of saying the same thing (although my piece would have been less colorful, more pedantic, and less fun). Read what Josh says!
A portfolio anchor. You need stability. If you are trying to do it with bond funds, you need to understand the risks. I prefer owning specific bonds. I have had some excellent comments and emails on this theme, and I am working on a joint post that will further clarify.
Stretching yield. My approach is to find some reasonable dividend stocks and sell near-term calls against the positions. If you did this skillfully, you could hit double-digit annual returns with significantly less risk than simply owning dividend stocks.
A little octane. Many investors do not think carefully about asset allocation. There is always volatility, so the key is to "right-size" your position. Instead of trying to time the market, try to be a player in the right sectors, the right stocks, and the right size.

We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback. We have a good discussion going on bonds versus funds, and I plan a separate article that will provide a further forum.)

Final Thoughts on Dangerous Curves

I am following four themes:

Mistakes about the Fed. Regular readers know my feelings about trying to explain every twist and turn of the market. The financial media are hungry for content, and pundits are happy to oblige. Usually it is best to ignore.

Friday was a bit different. Stock futures got a boost from the pre-market release of the employment report. The selling during the day took the market to the lows, a swing of 200 points or so in the DJIA. Some writers were revising their stories, trying to find something wrong with the employment report -- a real stretch given the size of the move. Some attributed the selling to continuing coverage of Sandy, with damage estimates rising -- perhaps.

Other reports of trader thinking suggested that the employment news might mean a change to Fed policy and QE3. (Steven Russolillo covers the story for MarketBeat and Bob Pisani had a similar report on CNBC). I am not questioning these reports, but the reasoning of those cited is dubious at best.

The most important aspect of the QE3 announcement is that the Fed is not going to change policy because of a data point or two, or three or maybe even five. They have embraced a different policy approach, looking for solid indication that the deflation threat has been addressed. There is more willingness to tolerate some inflation to reach that goal. It is an important lesson which those fighting the Fed will eventually learn. For starters, readers should look at the public statements of Fed members from the last week: Fed’s Kocherlakota: Fed May Not Be Providing Enough Stimulus, Fed’s Rosengren: Fed Should Buy Bonds Until Unemployment Hits 7.25%, Fed’s Williams: New Stimulus Is Having Its ‘Desired Effects’.

The fiscal cliff. This is the big wild card for the economy. My working assumption is that the pieces are in place for a compromise, perhaps launched with a delay, under any election scenario. I have considered each, finding a core of supporters. While I prefer to elaborate after we have the results, it is the key economic issue. Failure to deal with this problem is the single biggest challenge to our non-recession forecast.
The pause in business investment. Decisions have been deferred and cash is piling up. This has not been an economic disaster because the consumer has stepped up. If businesses get more certainty from the election (even if not the rules they want) I expect a change.
The upside risk. Most investors do not even worry about missing the upside. They are in all of the wrong places and will start worrying when it is too late. Investors will get a statement or two that shows losses in their bond funds at the same time stocks are rallying. After that plays out for a few months, we can start to worry about a market top.

And finally, the biggest worry --- a no-decision in the election. I understand that there are confident pundits predicting victory in both directions. Let us suppose that a key state -- Ohio or Florida -- does not have a decisive outcome on election day. Let us further suppose that this result swings the election. I can even imagine outcomes where the election would be determined not by the Electoral College tabulation, but in the House of Representatives.

As I noted last week, the market hates uncertainty, so this would be the worst case.

November 03, 2012 in Election 2012, Fed Policy, Individual Investors, Markets, The Week Ahead | Permalink | Comments (12) | TrackBack (0)

September 08, 2012

Weighing the Week Ahead: Will the Fed Disappoint the Markets?

After weeks of buildup, culminating with Fed Chair Bernanke's Jackson Hole speech, the time for decision has arrived. While some of the economic data is better, the jobs picture remains poor. Friday's employment report has raised expectations for some aggressive action. Are these hopes justified, or will the Fed disappoint the markets?

I was very accurate last week in predicting that the story would be all about jobs. The Democratic Convention, the pundit commentary, the GOP response, the media focus, and the Thursday and Friday data all followed this theme. Given Friday's disappointing employment situation report, the question became, What now? I suggested in my employment preview that reaction would be dampened by the expectation of more aggressive Fed action. This is exactly what we saw from Friday's trading.

Market Background

The general expectations have shifted, setting the bar higher. Here is the take from Jon Hilsenrath, who seems to have the pulse of the Fed:

"Officials have been leaning toward an open-ended bond-buying program in which the Fed holds open the possibility that it will continue to buy bonds after an initial allotment is purchased if the economy doesn’t pick up. They also have been leaning toward purchasing mortgage backed securities."

Michael Derby at the WSJ Real Time Economics Blog notes that the expectation is now "QE3 and more."

The expectations from these sources are at odds with the investment posture of both the Street, and the public. Check out two of my favorite sources.

Barry Ritholtz has tracked the "most hated rally" so check out his article for the history. Here is the chart that shows why this is important -- the underinvestment of some big firms.

Josh Brown shows the same psychology on the part of average investors, explaining that they have left $65 billion on the table through recent decisions to bail out of stocks.

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog. Ben Fox Rubin and Steven Russolillo go beyond the formal list of economic releases by mentioning major earnings reports, speeches, and even conferences.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

There was a fair amount of good news last week.

The ISM services index provided an upside surprise. The employment component is especially encouraging. Bespoke has a comprehensive look with the components individually listed and charted. Here is the overall history, but the full article is worth a look.

Home prices continue to rise as measured by CoreLogic. Global Economic Intersection has an excellent discussion and charts comparing different approaches. Here is a sample:

Productivity was up 2.2%, handily beating expectations. Productivity gains have come from corporations doing more with fewer workers. At some point they will need to add workers to meet growing demand. Meanwhile, this is good news for profits.
Job creation was strong, according to ADP and various other analysts, as I described in my monthly employment report preview. I understand the need for some "official" result, and the BLS method is very good. Alternative approaches are also very good. In the richness of time, these estimates often prove to be more accurate.
Auto sales are rebounding smartly (via Scott Grannis).
The ECB delivered on promises. Unlike many of the past incremental steps in Europe, this one did not generate a "sell the news" reaction. The potential open-ended nature, the willingness to take equal status with private investment, and the assertion of power to act independently from government decisions were all factors. The one downside element was that the purchases will be "sterilized" so that the overall balance sheet does not expand. This is not the all-out money printing that some craved. The overall effect was rather amazing, stretching into the 10-year yield for Spain and Italy, even though that is not where the ECB proposed to buy. Attitudes seem to be changing, as reflected in market prices.

The Bad

There was negative news, lesser in quantity but greater in importance.

Earnings forecasts drift lower. Brian Gilmartin, an expert on earnings both for individual companies and the overall market, tracks these trends very closely. (Similarly, Dr. Ed Yardeni) He notes the recent weakness and acknowledges the debate about what is already priced into the market. On his excellent new blog he writes as follows:

"...(A)ccording to ThomsonReuters – 2nd quarter, 2012 earnings are still expected to grow at 1.3% ( ex Bank of America and the financial sector) and 3rd quarter, 2012 earnings, which we continue to think will be the bottom for this cycle in terms of the earnings slowdown, are expected to decline year-over-year at a -2.1% rate.
The forward 4-quarter estimate for the S&P 500 estimate as of late last week was $108.02, exactly where it was 1 week ago."

Economic confidence remains weak (via Gallup). This measure is off the lows from last year, but still very weak -- a bad sign for consumer spending.
Foreign economic indicators (Europe and China) all declined last week. I always watch these -- always. It is how I start my day, and I often comment on them in my daily diary at Wall Street All Stars. I understand that we have a global economy, and I want to put it in perspective. Offsetting some of the decline, China will do more stimulus. Analyzing the impact on US stocks is a challenge.
The official jobs numbers reflected a weak economy, worse than expected and worse than needed. Discussing this objectively is nearly impossible for most, since the issue is so salient for voters. There was nothing good about this report. The net job gain of 96,000 is less than needed to keep up with the growth in population (perhaps 125k, although the target changes with trends in retirement and immigration). Downward revisions for the last two months subtracted another 40K jobs, half of which were in government. The household survey also showed a decline in jobs, although this series has fluctuated wildly. The decline in the unemployment rate was not statistically significant (after rounding) and mostly reflected a reduction in the labor force.

The official employment data is roughly consistent with the rest of what we see -- growth of 2% or so. Putting aside the political rhetoric, everyone realizes that more economic growth and a greater increase in net jobs is needed.

The Ugly

The ugly award goes to the rather surprising result of diversification into commodities. Tom Brakke always combines clear-headed analysis with great charts. He analyzes the concepts behind the chart below. Check out the full discussion, but this point describes investor behavior: "Investors have embraced these alternatives, only to find that they don’t really know much about them other than they’re not stocks or bonds."

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.

The evidence against the ECRI recession forecast continues to mount. It is disappointing that those with the best forecasting records get so much less media attention. The idea that a recession has already started is losing credibility with most observers. I urge readers to check out the list of excellent updates from prior posts.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's article describes the complete history, the critics, and how it has played out. The article highlights the most important economic indicators used in identifying recessions, showing that none have rolled over. Doug updates the recession debate every week and includes a great chart of the "big four" indicators used by the NBER in recession dating.

Meanwhile, the ECRI story continues to change. The latest variation is that the data will eventually be revised lower to show that we are already in recession.

Note on the Fiscal Cliff -- A thoughtful reader asks whether our recession forecasts include the fiscal cliff, a good question. Methods derived from historical experience are not helpful on issues like the cliff, so the general answer is "no," but some of the market-based methods will capture this as the time comes closer. I treat factors like the fiscal cliff, the collapse of Europe, the collapse of China, an attack on Iran, and similar factors as relevant elements of "tail risk." There is no good way to incorporate these into standard recession forecasting methods, so no one even tries. (I am ignoring those with a semi-permanent recession forecast!)

I frequently cite and monitor these factors in the weekly commentary, especially in "the ugly" section. If you insist on waiting for a time when there are no low-probability risks, you are a spectator, not an investor.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we continued with our recent switch to neutral. We have been bullish since June 23rd, with a one-week move to neutral a month ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved lower, and the confidence has deteriorated from last week.

The Week Ahead

There is plenty of data coming this week, but two events loom large:

The German Constitutional Court ruling (W, before US markets open). The feeling is that the Court will accept an increased German role -- -perhaps 80%. If not, there will be a scramble to figure out what portion of current plans may still be feasible.
The FOMC announcement and Bernanke's press conference (Th afternoon)

The "A List" includes the following:

Trade balance (T) with implications for GDP.
Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.

The "B List" includes several reports:

Industrial production (F).
Michigan consumer sentiment (F) which has implications for consumer spending and employment.
PPI (Th) and CPI (F) are sometimes important, but only if we get a few scary reports. That would create a dilemma for the Fed.

The time from the market opening on Wednesday through the FOMC announcement on Thursday will be the most crucial hours of the week.

Trading Time Frame

Despite Felix's overall "neutral" posture, our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have been getting a little weaker, but the trade continues to be profitable.

Felix does not try to call tops and bottoms, but instead keeps us on the right side of major moves, either up or down.

Investor Time Frame

Long-term investing is an objective for many of my clients, so I give it a lot of thought. Each week I try to provide an idea or two that will be useful for those sharing this perspective. Here are two new ones.

How much risk to take. The right answer is different for everyone, but too many people choose "zero." These investors do not follow the Buffett advice of buying when others are fearful. Then, when the market rallies, they are afraid that they are "too late." I wrote a new article, Stock Prices and the Fundamentals: Don't be Fooled, showing how to avoid this trap.

How to pick dividend stocks. Regular readers know that I am fussy about my choice of dividend stocks and I like to enhance yield by selling near-term calls against the position. Carla Pasternak explains why it is important to look beyond the yield, finding companies that also represent good value. This is a fine article, combining both a great approach with some specific ideas.

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;
Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
Added some octane with a reasonable allocation of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments welcome!)

Final Thoughts on the Fed

Before this week I was not expecting an aggressive action by the Fed, but my own opinion changes with the data.

The mistake made by most is a collection of dangerous ideas -- OK for politics, but risky for trading and investing. In the absence of a better term, I'm going to call it the Fed Skeptic Syndrome.

The Fed Skeptic has the following collection of beliefs:

QE has no positive economic effect. It has not helped employment and has boosted stocks only because the Fed bond buys act like direct purchases of stocks and commodities -- in addition to pushing conservative savers into tech stocks and soybeans. Fed action has artificially kept stock prices and the economy higher, but is ineffective. You can see this because things are worse than they were a few years ago. It is all a sugar high, and it will end badly either through deflation, or hyperinflation, or both. These forecasts are certified by an array of "chief investment strategists" whose credentials do not include economic education but do include frequent media appearances. The most popular are "self-taught in Austrian economics."

The FOMC has the opposite viewpoint:

QE has lowered interest rates by a few bps and generated a gain of about 2 million jobs over what otherwise would have happened. There was no direct effect on commodity prices. Misguided speculators drove these prices higher. Stock price increases reflected the improved economic prospects from the program, and also created a virtuous cycle of confidence and wealth effects. The proponents are all credentialed mainstream economists of both political parties.

As a voter, feel free to take whatever perspective you want.

As an investor, it is wise to understand those who actually have power, and predict what they will do. Most of those who are missing the rally do not have sufficient respect for the determination and power of government officials.

September 08, 2012 in Fed Policy, Government, Individual Investors, Markets, Recession Series, Reviewing Pundits, The Week Ahead | Permalink | Comments (2) | TrackBack (0)

August 25, 2012

Weighing the Week Ahead: Hopes Too High for Jackson Hole?

After weeks of anticipation, we may get the answer to a key question:

Will the Fed launch another round of Quantitative Easing?

Since the decision for QE II is linked to Fed Chair Bernanke's 2010 speech to the annual Economic Symposium at Jackson Hole, some expect a similar outcome this time. There is obvious confusion.

Stocks rallied as the Fed minutes seemed to show a greater receptiveness for more QE. Stocks sold off when St. Louis Fed President, a non-voting member whose hawkish views are well-known, said that the minutes were "stale" and that data had improved. Stocks then rallied a bit when Chicago Fed President Evans basically said the opposite. Finally, there was a significant reversal on Friday when WSJ reporter Jon Hilsenrath released a letter from Bernanke to Congressman Darrell Issa (R, Cal.), responding to some questions he had posed by mail. The answers contained nothing new, but market participants seized upon the date of the letter! The idea is that this is the most recent information.

Here's more evidence of confusion, dedicated to those who are always opining about the "message of the market."

Headline in LA Times: Price of gold surges on Fed stimulus hopes; is it headed for $2,000?
And from Reuters: Wall St falls on dimmed Fed stimulus hopes, data

Two stories -- published within minutes of each other. For the flexible pundit, it is easy to derive whatever message you want!

Figuring out what the market really expects is a big challenge this week. I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

There was quite a bit of economic data last week, and it had a generally positive tone.

Rail traffic is modestly higher (via Cullen Roche).
Taxpayers cashing in on toxic assets. While we are still toting up the net results, some of the bailout decisions have paid off on the specific investments, in addition to the possible benefit for the overall economy. Here is a nice article on the subject by Todd Sullivan (always worth reading).
Durable goods set a record high. Some definitely embraced the bright side. Here is Mark Perry's chart (but also see below under 'The Bad").

Auto sales are solid. In support of the full durable goods metric, Mark Perry also cites the authoritative JD Power survey, suggesting that car sales will reach a 4 1/2 year high. This is clearly helping employment and GDP, so it seems relevant.
New home sales continue to improve. Here is the chart from Scott Grannis:

The Bad

The was a little negative news.

Gasoline prices moved higher, up another eight cents (via Doug Short) and getting into dangerous "choke collar" territory (via Bonddad).
Individual investors are more bullish in the American Association of Individual Investors Survey. This is a contrarian indicator, of course, suggesting that those in the survey are mistaken. Here is the helpful chart from Bespoke. Because of the honest depiction of data, you can judge for yourself whether the relationship is strong and enduring.

Chinese growth is overstated and falling. Here at "A Dash" I have frequently mentioned this concern. There is additional evidence (via The Big Picture) that official data exaggerates the story in China. Meanwhile, the flash PMI from HSBC showed contraction in the headline number and also specific categories. It is important to monitor developments in China.
Core durable goods are weak, especially in real terms. Doug Short does a series of adjustments for population, inflation, and non-transportation expenditures. His take is much more discouraging than Mark Perry's (above). Steven Hansen claims the middle ground. Here is Doug's summary chart, but it is important to read the entire article and see the complete series of charts if you want to understand the argument.

Bearish indicators -- both short and long term -from Dr. Ed Yardeni. Here is the chart for his three-variable fundamental method.

His conclusion is as follows:

"On balance, I think that stock prices may move sideways between now and the November elections. It’s certainly hard to characterize the rally since June 1 as a “Romney Rally” given that the presidential race remains in a dead heat. A few pundits have suggested that it’s actually been an “Obama Rally,” figuring that the market favors the devil we all know rather than the one we don’t."

The Ugly

The fiscal cliff -- as explained by the CBO. The nonpartisan Congressional source sees an economic contraction of 0.5% if Congress fails to act on the looming changes to current law.

James Hamilton has A Dream, and it is a good one! He accurately notes that the problem lies with a system of government where we reward pandering to specific interests. Here is his very sensible assessment:

"Let me begin by making clear my personal position up front. I think America faces a serious long-term fiscal challenge. Not one that needs to be addressed in 2013-- trying to fix this all at once would be highly counterproductive. But I believe that the American political system is badly broken. The voting public expects to get something for nothing, and the two parties compete to promise to give them exactly that. I'm persuaded that both tax increases and drastic entitlement reform will eventually be necessary. I would like to see debate and even a consensus reached today on exactly how we plan to implement both measures over time."

If only we could see such wisdom. Professor Hamilton suggests that either or both candidates might benefit from demonstrating the ability to compromise. We'll see the first act this week in Tampa.

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. Think of The Lone Ranger.

This week's award goes to New Deal Democrat at the Bonddad Blog. He takes on the latest oddball recession indicator: Trash!

Michael McDonough from Bloomberg hit the circuit with this chart:

He had some fun by "talking trash" in the interviews. The chart aligns the two series based upon the most recent and most dramatic decline in 2009. It is pretty rough before that. The eyes can deceive.

But NDD delves more deeply. He also has fun by "trashing a garbage indicator" and invoking GIGO. He notes that the data is based upon quarterly results, but McDonough rushed to print and the talk show circuit with only part of a quarter.

In fact, the data from last year -- not this year -- seems to have been distorted by some abnormal results in the first part of the quarter.

We will not know the final verdict until the end of the quarter, but that is not the point. This is an error in data analysis and a premature announcement. I wonder if Bloomberg or NPR will follow up, as they should. Why not interview NDD?

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread.

Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I showed the significance of this last week by explaining the relationship to the business cycle.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's article, Economic Data Continues to Refute ECRI's Recession Call describes the complete history, the critics, and how it has played out.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we continued as bullish. We have been bullish since June 23rd, with a one-week move to neutral a few weeks ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings are higher, and the confidence is improving.

The Week Ahead

This is a big week for economic data.

On my A List are the following:

Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy
Consumer confidence (Conference Board - T; Michigan -F) important for employment and spending
Beige Book (W) which normally does not surprise, but will have heightened attention this month

Also important are these:

Housing data including Case-Shiller prices (T) and Pending home sales (W)
Chicago PMI (F) which is important as a pre-weekend clue about the national ISM report
Personal income and spending (Th). July data, but interesting to confirm retail sales
Q2 GDP revisions. Backward looking but still important given the modest growth levels.

The GOP convention will grab some headlines. It will be interesting, but I do not see an immediate market angle.

Most important of all will be the Jackson Hole symposium, with Bernanke's morning speech on Friday and Draghi scheduled on Saturday.

Trading Time Frame

Our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. As the tape has improved, the ratings from Felix have gotten stronger.

Felix does not try to call tops and bottoms, but keeps us on the right side of major moves. We had one "neutral" forecast about a month ago, but things never got weak enough to reduce positions.

Investor Time Frame

More sources are joining us in warning about chasing yield. Jacqueline Doherty does a great job on this front in the current issue of Barron's, The Danger in Dividend Stocks. She looks at valuations on a sector-by-sector basis, noting "nosebleed valuations" for popular companies like Southern Company (SO) and Verizon (VZ).

Dividend investing is fine, but you must look past the dividend yield and study the earnings, earnings growth rate, cash flow, balance sheet, and payout ratio.

Scott Murray astutely observes that the volatility indexes seem out of line with reality. He notes the potential for some sophisticated arbitrage opportunities, but these are not available to the average investor. The most important lesson is his warning about buying volatility because you have read about headline risks. How many times must we repeat that the market has already priced what you read in your morning paper?

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;
Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
Added some octane with a reasonable input of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

Final Thoughts on Jackson Hole

Last week I predicted that the Fed will eventually act, but perhaps with something other than another round of QE. Jon Hilsenrath's take plays this down, and he has good connections. Perhaps I am wrong. I remain open to new information.

I do not expect anything significant from Jackson Hole, so there is potential for a market disappointment. It would not be the first time that I have disagreed with Felix, and the verdict has been mixed!

Here is my rationale:

Jackson Hole is typically not the forum for policy announcements. It is an occasion for mixing and exchanging ideas. Most speeches by the Fed Chair are of the cerebral and background variety.
The 2010 Bernanke speech is a piece of Wall Street truthiness. In fact, there was little immediate market reaction. Stocks were lower a few days later. It was only after a big rally that those seeking a bogus correlation reached back to the "hints" from the Jackson Hole speech. In fact, there was nothing new in these hints, and the official policy did not start until November. When someone is on a mission to prove something, and has a choice of starting dates, it makes it easier to create bogus correlations.
The jury is still out. There is no reason for Bernanke to tip his hand before getting the employment report for August.

I have a dozen links (not included) to stories speculating about this and forcefully explaining what the Fed should do. Most of them confuse personal opinion and politics with forecasting.

For those seeking investment success, the key question is what the Fed will do, not what you think it should do.

August 25, 2012 in Current Affairs, Fed Policy, Government, Individual Investors, Markets, The Week Ahead, Trading, Yield | Permalink | Comments (5) | TrackBack (0)

July 26, 2012

Four Common Mistakes about the Fed

The Fed is a favorite target for the financial punditry. Anyone can and does join in, offering ideas that are completely without evidentiary support. Meanwhile, there is plenty of factual information about the Fed, but it is widely ignored.

Here are four common mistakes that you frequently see in the commentary from the pseudo-experts. These blunders are so widespread that it is pointless to cite a specific source.

The Fed is Sidelined by the Upcoming Election

This one is a persistent theme among those who have absolutely no special knowledge or experience. Many pundits analyze government organizations by pretending that the policymakers are a small group with a strong common motive and the ability to act in secret. They basically take their own limited experience about how the world works and assume that they can explain government actions that way.

One reporter from the floor recently reported the latest convoluted notion: The FOMC would not act at next week's meeting, but would instead delay so that the positive effect of its policy action would not occur before the election.

That is really deep! Some of the same sources show a chart that quite liberally changes the dates of Fed policy to correspond to market moves. In some cases the move occurs at the first hint of a policy change. This is completely inconsistent.

The Fed Acts Based Upon the Stock Market

One commentator recently opined that the Fed would not act right now because the stock market was not really threatened. The Fed would wait until there was a serious selloff to use its few remaining bullets -- maybe 1100 in the S&P.

In fact, there is absolutely no evidence that the Fed acts to prop up the stock market. The Fed behaves in line with a dual mandate for stable prices and low unemployment. With prices not a threat, the emphasis is on economic growth.

There is a source of confusion -- the Fed embraces the stock market as one source of how well they are doing on the economy. While the objective is not directly to support stock prices, a successful economic policy would have that result. The occasional reference to higher asset prices is pounced upon by conspiracy buffs.

How can we tell the difference?

We could listen to Bernanke's testimony, where he has repeatedly stated the economic objectives -- and also that the political circumstances are not a factor.
We could go to the official transcripts of the meetings, now available for many years and extending up to 2006. These are full transcripts. If someone wants to assert political or stock motivations, let him find the evidence in the actual record. Put up or shut up!
Forget the stupid conspiracy notion. The FOMC meetings have many participants, some of whom would be happy to report any secret moves.

The Fed is Out of Ammunition

A popular theme is that the Fed can do little more because short rates are already at near-zero levels and the perception is that the effect of asset purchases has been reduced.

It is difficult to discuss an erroneous viewpoint without specifying a source, and I do not want to create a straw man. With this in mind, the Fed critics -- who have been on the job for years -- did not imagine any of the current actions either. The "out of bullets" meme is many years old. Why should we believe them now?

Instead, you could look at commentary from an actual authority, a former Vice-Chair of the Fed. Alan Blinder, writing in the WSJ, offers five different ideas that the Fed could use. Any of these surprises could catch traders leaning the wrong way.

The Fed Knows the Employment Data

This is a bonus item. I predict that whatever the Fed does next week, the talking heads will speculate that it is based on an early read from the employment report.

This idea is completely false, and contravenes official regulations. The President gets an early look on Thursday afternoon (via the Council of Economic Advisors) and the Fed gets a few data points to help with their Wednesday release on Industrial Production.

That is all!

This was a specific question in a BLS webinar that I attended two years ago. Here was the answer:

11:01

Angie Clinton (BLS-CES):

Submitted via e-mail from Paul: Question
QUESTION: What are the rules or law governing the confidentiality of the monthly jobs reports? When is the report/information released to the media (even though it may be embargoed for a few hours). Are DOL officials or other Executive Branch officials permitted to publicly discuss any information about those reports before they are released to the media and public? Thank you.
ANSWER: Thanks for your question Paul. The Office of Management and Budget directs Federal agencies on the compilation and release of principal economic indicators. Statistical Policy Directive Number 3 designates statistical series that provide timely measures of economic activity as Principal Economic Indicators and requires prompt release of these indicators. The intent of the directive is to preserve the time value of such information, strike a balance between timeliness and accuracy, prevent early access to information that may affect financial and commodity markets, and preserve the distinction between the policy-neutral release of data by statistical agencies and their interpretation by policy officials.
According to the guidelines set forth in this directive, the BLS provides prerelease information to the President, through the Chairman of the Council of Economic Advisers, the afternoon before release of the Employment Situation. Statistical Policy Directive Number 3 is available on
http://www.whitehouse.gov/omb/assets/omb/inforeg/statpolicy/dir_3_fr_09251985.pdf .
The directive contains the following language regarding public comment: “Except for members of the staff of the agency issuing the principal economic indicator who have been designated by the agency head to provide technical explanations of the data, employees of the Executive Branch shall not comment publicly on the data until at least one hour after the official release time.”
CES and CPS data are embargoed until the scheduled release date and time. The Federal Reserve has a memorandum of understanding with BLS to obtain specific employment and hours series for manufacturing, mining, utilities, and publishing for purposes of producing estimates of industrial production on Wednesday at 8:00 AM prior to the release. The Council of Economic Advisors receives the news release on Thursday afternoon, the day prior to the release. The Chief Economist at the Department of Commerce and the Secretary of Labor receive the news release at 8:00 on the morning of the release. Members of the press and the staff of the Joint Economic Committee of Congress (if there is a JEC hearing) receive the news release under strict lockup conditions at 8:00 AM on the morning of the release.

Friday June 4, 2010 11:01 Angie Clinton (BLS-CES)

This is quite authoritative, and you will definitely not see it anywhere else. My fearless forecast is that the conspiracy buffs will be in action on this next week!

Investment Conclusion

The basic conclusion for investors is a familiar one for readers of "A Dash." There is no substitute for finding actual experts and sources. Accept no substitutes!

Bernanke will act if additional economic weakness indicates the need. He will not have advance info on the employment report, so Fed action might not occur at the upcoming meeting. While it may be fun to speculate on conspiracies and politics, this is not the path to a profitable investment.

Fighting central banks is a losing proposition for investors.

July 26, 2012 in Contrarian Investing, Fed Policy, Individual Investors, Markets, Trading | Permalink | Comments (12) | TrackBack (0)

June 09, 2012

Weighing the Week Ahead: A Search for Leadership

I cannot do justice to the concept of leadership in one article, but let us hit the highlights.

Leadership is what most market commentators want when they complain about "politicians." They want leaders of democracies to ignore the demands of constituents and do what is right. Unfortunately, the punditry has widely varying views on the best course of action!

The search for leadership is hitting center stage.

Leadership requires more than accepting and following opinion polls. It includes finding solutions and convincing people that this is the right path. Bringing contending parties together. Finding compromises. Personal charisma. A persuasive presence. Confidence in the face of crisis.

The need for strong leadership is readily apparent, but why the focus right now? I see three factors:

The upcoming Greek election, which may well determine whether Greece leaves the Eurozone and on what terms;
Increased urgency among European leaders, as austerity programs fail both with voters and in economic results;
Intensifying US politics, with a new focus on the personal skills of the candidates.

This last point, highlighted by Obama's press conference comments, will be the big topic for the weekend talk shows and featured in financial news this week. It is difficult to find a really neutral link for this subject, and you can easily find many on your own, but this coverage from Business Insider provides both facts and context. It shows the actual statement and plenty of quotations from Republicans, but also some data.

I'll offer some thoughts on this in the conclusion, but first let's do our regular review of the events and data from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The US economic data last week was more positive than in recent weeks.

Technical selling was averted. This was a big fear last week. Josh Brown did a great job of explaining why this might not happen. I hope readers followed our link to his analysis.
ISM Services index showed continued expansion. Steven Hansen does a good job of analyzing the internal elements and also provides a helpful chart.
Spain has agreed to accept outside aid for its banking system. The $125 billion is three times the amount cited by the IMF as needed. (New York Times). The terms were structured with an emphasis on bank reforms rather than new austerity measures. German officials praised Spain. This is the sort of face-saving compromise action that investors should be watching as a sign of progress, as I suggested in my Europe surprise ending article.
Sentiment continues to be very negative, which is positive for markets. Steven Hansen highlights the increased bearishness in the Ticker Sense survey of bloggers (including "A Dash). The Bespoke Investment Group shows the same picture for individual investors.

US household balance sheets are $1 trillion better than in 2007. Scott Grannis notes that this has not led to the widely-predicted economic implosion.

The Bad

There was also some bad news on the economic data front.

France lowers the retirement age by two years, to age 60 for some workers.
The European bank"job" continues -- good story from Floyd Norris at the NYT.
US debt will reach 200% of GDP by 2037, according to the CBO, if Congress extends current tax policy without cutting entitlements.
Initial jobless claims remain at unacceptably elevated levels. I see this as the most important of the weekly data series. The chart from Doug Short shows why:

Big US banks face downgrades according to the WSJ.

"Moody's Investors Service has said it is likely to reduce by the end of June credit ratings for 17 large global banks, including five of the six biggest U.S. financial firms by assets. The downgrades are expected to raise borrowing costs and crimp some lucrative trading businesses at the banks...."

PMI reports from around the world have been weaker. Dr. Ed Yardeni has a good discussion about the differences between the US, China, and Europe. The US is holding up best, but there is a general weakening pattern as you can see from this chart:

The Ugly

The Greek television talk show wins this week's "ugly" award. The neo-Nazi politican is now on the lam after slapping and slugging a woman from the Communist party. The New Athenian is one of our featured sources, so we recommend this video of the incident, where John Psaropoulos does the reporting.

Speculation ranges widely on what effect this might have on the upcoming election. No guesses here!

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon. We are working on a modification that will make this method even more sensitive. None of the recession methods are worrisome. Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are also not close to a recession signal.

For comprehensive recession forecasting we recommend the RecessionAlert team. They have reverse-engineered the ECRI approach and improved on the recession forecasting power. Since they have not gotten the mainstream recognition they deserve, you can still enjoy the advantage from their methods. You should consider subscribing for more detailed reports covering various time frames and GDP forecasting.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. This week we continued as "bearish" and were 1/3 short via DOG in trading accounts during the week. The ratings are close to neutral. There are sectors in the buy range which might emerge from the penalty box, so this is a very fluid situation. It is bearish, but marginally so.

The Week Ahead

I was correct last week in my prediction that the financial news would have a Fed fixation. All of the Fed speeches, including Bernanke's testimony, passed uneventfully. The Beige Book showed a the economic strength that the Fed sees but traders do not. Yellen offered some QE hope, but Bernanke did not. We are now waiting until next week's FOMC report without any further direction.

There is plenty of data this week, but little that I see as important. I don't expect much on the inflation front and I do not care about regional surveys like the Empire State Index.

On Thursday we will see initial jobless claims, still in the survey period for the next employment report. On Friday we get industrial production, capacity utilization, and Michigan sentiment. Then we get pre-weekend speculation about Greece and options expiration.

I expect the first part of the week to focus on the leadership questions, with attacks on Obama as "out of touch."

Trading Time Frame

We have been partially invested in trading accounts, in a bearish position with 1/3 of our position profitably in bond ETFs and another 1/3 in an inverse (short) ETF, as I predicted last week. Felix has now sent the bond position to the penalty box, so we have a cautious short position.

Investor Time Frame

For investment accounts I have been buying on dips in stocks that we like. I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look. You can contrast this with the many pundits who claim miracles of market timing.

The single most difficult thing for me to explain is that investors should often embrace opportunity just as traders are trying to do some fancy footwork. Investors should not be trying to guess the next market move. Instead, take what the market is giving you. You should not be a "buy and hold" investor, but instead engage in active management. Think about risk control rather than market timing.

To highlight the continuing discrepancy between headlines and the economic fundamentals, let us look to Dr. Ed. He compares various alternative investments to stocks, using the trailing earnings. This chart summarized a point that was widely observed in the past week.

The earnings yield from stocks, when compared to corporate bond yields, is at a 50-year spread. This suggests extreme skepticism about corporate earnings. Another way to view this is that it is the greatest fear since the mid-70's. If the two lines simply met, the S&P 500 would have to rally by 27%. This is conservative, since you can see that the bonds usually trade at a higher yield. If you used forward earnings or Treauries, the so-called Fed model, you would get an even larger discrepancy.

The biggest mistake that individual investors make is bad timing by following headlines. Using data is a way to avoid that.

Long-term investors who ignore this warning can follow "Plan B." You can imitate our enhanced yield program. Buy good dividend stocks and sell short-term calls. I am targeting 8-9% returns on this approach, and achieving it over the course of a market cycle. You can, too. With the increase in volatility, there are many good opportunities.

Final Thoughts on Leadership

I have a very good record of predicting what will happen, especially on political events. Eventually this pays off, since earnings follow and stock prices eventually track earnings.

My concern is that sometimes perceptions create their own reality.

Suppose you are considering a major business expansion -- a new product, new plant, or new employees. Economic uncertainty is the enemy of such plans, since you have less confidence in your forecasts.

Suppose your family is considering a new job, a new home, or a new car. Uncertainty can create a delay.

This is why the effect of leadership is important. Even if all will eventually end well, people need to have some confidence. Otherwise, why not wait until after the Greek elections, after the Europeans solve the problems, after the fiscal cliff is addressed, after the US elections......

This is why the extended US political process is so destructive, particularly when it incorrectly focuses on the personal competence of the candidates.

Here is a secret: The things most important to investors will be fine no matter who is elected. Both candidates are competent and will have great supporting teams.

The perceptions create an economic drag, but investors who wait for everything to be fixed will be buying at Dow 20K.

This is a challenging subject and I need more articles to explain. Meanwhile, I try each week to highlight the most important things I am following.

June 09, 2012 in Europe, Fed Policy, Government, Individual Investors, Interpreting Data, Market Valuation, Markets, Politics, The Week Ahead | Permalink | Comments (2) | TrackBack (0)

A Dash of Insight

An eclectic approach to better trading and investing. Finding market inefficiency. Discussing and applying the best ideas and methods from several disciplines.

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March 03, 2013

Weighing the Week Ahead: Is There a Stop Sign at the Old Market Top?

Boehner says no new taxes after sequester meeting in White House

Pelosi: No budget deal without new revenues

'I am not a dictator,' Obama says

January 10, 2013

Business Cycle Forecasting: The First-Rate Results of Robert F. Dieli

January 05, 2013

Weighing the Week Ahead: Are Earnings Expectations Too High?

December 15, 2012

Weighing the Week Ahead: Clarity Coming on Key Market Challenges?

December 08, 2012

Weighing the Week Ahead: Something New from the Fed?

November 03, 2012

Weighing the Week Ahead: Approaching Dangerous Curves?

September 08, 2012

Weighing the Week Ahead: Will the Fed Disappoint the Markets?

August 25, 2012

Weighing the Week Ahead: Hopes Too High for Jackson Hole?

July 26, 2012

Four Common Mistakes about the Fed

June 09, 2012

Weighing the Week Ahead: A Search for Leadership

Individual Investors: Start Here!

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