A Dash of Insight

Weighing the Week Ahead: Are Consumers Ready to Buy? What about Housing?

The economic recovery, to the surprise of nearly everyone, has been consumer-driven. This has occurred despite increased savings and an overall improvement in household balance sheets. Businesses have been cautious to invest and to hire. State and local governments have been slashing spending and employees.

I expect a week with a consumer focus. It starts with data on retail sales, expected to be weaker from the payroll tax increase and lower gasoline spending. It ends with the important indicators on housing. There are several possible themes this week, but I expect the role of the consumer to be at the forefront of the discussion.

If you read but one piece in preparation I recommend the chart and data-filled speech from Fed Governor Elizabeth Duke, alertly reported at Global Economic Intersection. Here is a sample of the many good charts, but it is only one theme out of many.

I have some thoughts on housing and the consumer 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 regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
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:

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

The Good

This was a good week for the markets, but it was a light week for data. The story was mixed.

• The projected US budget deficit for fiscal 2013 is now more than $231 billion lower than for 2012. (via the CBO). This is due to a combination of relatively modest spending increases and much higher revenues. It will provide some additional flexibility for policymakers to negotiate more comprehensive solutions.
• Banks are easing lending standards (via Calculated Risk). This is necessary for the widely-noted increase in the Fed's monetary base to turn into actual "money printing."
• Hotel bookings are strong (via Calculated Risk). That coincides with my personal experience!

The Bad

The thin data week included a little bad news.  Feel free to add in the comments anything you think I missed!

• The improved debt picture comes at a cost. Menzie Chinn discusses the impact of austerity in general and the sequester in specific. It is a lower path to reduced unemployment and slower economic growth. Most estimates of Q2 GDP growth have been lowered as a result.
• The earnings beat rate dropped significantly this week, and the revenue beat rate is even worse. Here is one of the summary charts from Bespoke (check out the full article for the full story). And see Paul Vigna at the WSJ for a great discussion of specific factors.

• The Administration is looking for volunteer funding to implement ObamaCare. Good luck with that!

The Ugly

This week's ugly award is another Twitter effect. While not as big as last week's example, it shows how vulnerable we remain to rumors. This time the rumor hit on Thursday afternoon. The story was that John Hilsenrath, the well-connected Wall Street Journal reporter on the Fed beat, would release a story about the ending of QE. The story was expected to hit about an hour before the market close.

Stocks sold off on the rumor about a rumor. You could follow the discussion on Twitter -- a place where people explain market moves, but it also promotes moves for those who have advance information – even if they call it a rumor. You can check out the history and retweets here.

The substance of this rumor was pretty silly. The Fed members are all off giving speeches. They do not all agree. Hilsenrath's job is to write about this. Anyone paying attention knows that no policy change is imminent. You trade this stuff at your peril, as I wrote here. And here is the final WSJ article, coming out after the close on Friday.

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 Joe Taxpayer (with a HT to Josh Brown) for exposing another popular example of chart deception, over-fitting two data series by massaging the scales. Without the distortion there would be no nice-looking fit. Well done, Joe.

My problem is that I cannot award a Silver Bullet to someone refuting a straw man. It is much better if the winner identifies the source of the misleading information. I was not going to use this, but the misleading information was (not surprisingly) found at the most common source – ZH. While the chart is offered without comment, the "rating" is 4.5 from the enthusiastic crowd at that site.

[Question for readers: Should I only award the Silver Bullet when the author identifies the source of the error?]

Nominations are always open for more Silver Bullet candidates.

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, well worth your consideration. They did not supply updated data this week, but we hope to resume coverage soon.

Georg Vrba's model sees a decrease in unemployment to 6 percent in 2015, with a possible recession in early 2016. Georg has an array of interesting models on different themes – all with strong results, combining testing and real time.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. 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. He writes this week:

Here are two significant developments since ECRI's initial recession call in September 2011:

1. The S&P 500 is up 43.8%.
2. The unemployment rate has dropped from 9.0% to 7.5%.

Doug also reviews the latest (umpteenth) change in the ECRI methods, showing why there is nothing magical about nominal year-over-year growth in GDP of 3.7%. Short answer: low inflation.

The average investor has lost track of this long ago, and that is unfortunate.  The original ECRI claim and the supporting public data was 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 following us 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.  Over the last few weeks we have varied between bullish and neutral.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings have improved significantly over the last two 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.  Since that measure remains elevated, 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 plenty of data.

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.
• Building permits and housing starts (Th). Especially important right now.
• Michigan sentiment (F). Still not at recovery levels, and pressured by taxes and lagging employment.
• Leading economic indicators (F).  This is still a favorite for some.

The "B List" includes the following:

• Retail sales (M). Expect a slow start to the week due to reduced gasoline purchases and lower car sales.
• Industrial Production (W). Continues to be important in tracking economic growth.
• PPI (W). The headline numbers will be negative with a small positive for core (ex food and energy).
• CPI (Th). See PPI. No inflation pressure on the Fed.

Earnings season winds down. The regional Fed indexes matter only if there is an outsized move. The Fed members are on the speaking circuit, so expect plenty of (conflicting) signals from those sources. It is not like the Greenspan era, when members pretty much stayed "on message."

It is also options expiration week, adding to volatility.

Trading Time Frame

Felix has resumed a bullish posture, now fully reflected in trading accounts. It was been a close call for several weeks. Despite the move to a "neutral" overall rating, Felix continued to find at least three attractive sectors. The positions were pretty defensive until a few days ago. Felix has picked up the shift to cyclical stocks and technology.

To illustrate the change I have opened up my weekly column at Wall Street All Stars. This shows the entire rating list as of Wednesday, as well as my featured ETF for the week. (I am enjoying my participation with this group – especially the stock ideas. There are a many interesting suggestions from the community. One or more contributors will join in to answer questions).

As an additional update for WTWA readers, Felix added QQQ to the buy list on Friday. This is the only broad market ETF with a solid rating.

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.

The danger to avoid

Investments traditionally regarded as safe are now among those with the greatest risk. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. I highly recommend the excellent analysis by Kurt Shrout at LearnBonds. It is a careful, quantitative discussion of the factors behind the current low interest rates and what can happen when rates normalize.

Other yield-based investments have a similar or greater risk profile. As David Kehohane of FTAlphaville notes, even junk bonds are now yielding less than 5%!

A safer source of yield --what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%, with risk far lower than a general stock portfolio.

Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on new events and not enough on earnings and value.

Three years ago, in the midst of a 10% correction and plenty of Dow 5000 predictions, I challenged readers to think about Dow 20K. I knew that it would take time, but investors waiting for a perfect world would miss the whole rally. In my next installment on this theme I will deal with the logic behind the prediction. It is important to realize that there is plenty of upside left in the rally, as Barron's notes this week in the cover story, We Were Right!

For the investor with a reasonable time horizon, there are many fine opportunities. While some stocks and sectors are overvalued, there are still many good choices. BreakingViews has the story:

Todd Builione, president of JPMorgan-owned hedge fund firm Highbridge Capital Management, said at the SkyBridge Alternatives conference on Wednesday that cyclicals now present a historic opportunity. They may be vulnerable to economic winds, but for now there's a big discount to compensate investors for that risk.

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).

Final Thought

Will the consumer step up on housing?

New Deal Democrat at The Bonddad Blog does a comprehensive update of leading indicators. There are many good charts, but here is one that I closely follow – building permits. There is a nice trend, but a recent stutter.

It is a crucial question. Calculated Risk is the best source on all things housing. Bill thinks that the bottom is in, and is following various indicators for the exact timing of the rebound. Check out his analysis from one month ago and join me in watching this month's data.

Moody's Analytics' Mark Zandi sees housing leading a rebound in employment. The WSJ quotes him as follows:

Mr. Zandi said building should return to normal precrisis levels of 1.8 million homes built per year from 900,000 in recent years. He added that every single-family home that is built generates 4.5 new jobs, every multi-family property creates two jobs, while the activity creates demand for a multitude of building materials and services.

Whether or not you agree with these three sources, you know what to watch. And keep in mind that you cannot possibly do worse than Wall Street "strategists" who have missed the last 16% move (via Josh Brown) with their lowest stock allocation in history. If you have trailed in your investment performance, you are not alone.

March Employment Report Preview

Once again the monthly payroll report has a special significance. I am cautious for several reasons:

1. The market rally is generally perceived as extended – many are looking for a reason to sell;
2. The recent economic data has shown signs of weakness, possibly affecting consumption and business formation;
3. There is a ceiling on strength, due to incorrect assumptions about the Fed.

I will elaborate on each point in the conclusion, but let us first review the expectations for Friday's report.

Background

This preview is different! There are many concepts and facts that you will not see anywhere else. I also try to provide an angle both for traders and investors. There is an element of truth (what will eventually become clear) and an element of buzz (what will draw exaggerated attention Friday morning).

For many years I have written a regular monthly preview of the Employment Situation Report.  I have done extensive research on all of the methods and even visited the stat guys at the BLS to discuss their approach.

My preview gives appropriate respect to the BLS, but also to the leading alternative methods.  My best analogy was to a bean-counting contest.  The winner was NOT the contestant who was closest to the correct answer.  Instead, the winner had to predict the guess of a fellow contestant.

This is what we do every month.  We want to know the truth about the economy.  Instead of recognizing that there are several good estimates, everyone tries to guess what the BLS will report.

Please read this former preview both for a laugh and a deeper look.

Recently I did something extra, reviewing the most recent period for which we have actual data and showing who had the best estimate. There were three conclusions:

• All of the estimates were too low.
• The much-maligned ADP was the best, and that missed by more than 100K jobs.
• The BLS methods were the worst.

We rely far too much on the first pass, BLS version, and officially certified monthly employment report.  It is a natural mistake.  We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.  Whenever there is an important question, we all seize on any available information.  While we might know the limitations of the data, any concern is briefly acknowledged -- if at all -- and then swiftly put aside.

The Data

We would like to know the net addition of jobs in the month of March.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

1. An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
2. The report is revised to reflect additional responses over the next two months. 
   
3. There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone. Everyone focuses on the birth/death adjustment. This actually accounts for less than 20% of the BLS attempt to estimate job creation.
4. The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low, as revealed in the most recent report.  For the year ending in March, 2012, the BLS estimate was off by about 30K jobs per month overall, and 35k jobs per month on private employment. The January report adjusted for these benchmark revisions.

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer.  The BLS is actually like one of the contestants, with the full report coming later.  The market uses this estimate as "official" and declares winners and losers on that basis.  No one pays any attention to the final data, which we do not see for eight months or so.

• ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 158K private jobs on a seasonally adjusted basis.  In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate.  In recent months ADP is using an improved methodology with a stronger sample.  The objective is to improve the correlation with the final print of the employment data. 
• TrimTabs looks at income tax withholding data. Their idea is that this is the best current method for determining real job growth.  TrimTabs forecasts a gain of 156K. We are moving past the year-end uncertainty about tax law from the fiscal cliff debate, so one would think that the TrimTabs estimate would now be more accurate.
• Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).
• Jeff Method.  I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. This is on the summer research agenda – a time when I typically have help from smart people looking for great experience. While the Jeff model is still officially on the sidelines, it suggests significantly lower job gains than the other approaches. Put another way, on a long-term historical basis we would not expect gains of more than 100K given the other economic data. Is job growth really leading the recovery? I do not think we have a good grasp on job creation.  The BLS tries hard, but their approach lags on this front. Street estimates are generally similar to my method, but few reveal much about the specific approach.  These estimates usually adjust for the ADP report.
• Briefing.com cites the consensus estimate as 192K, while their own forecast is for 185K.  Their private jobs forecast is about 15-25K higher, since the loss of public jobs is a continuing drag.
• Gallup does not seem to have an update to their unemployment series. I have tried to give this source respect and equal time despite a rather overt bearish and political approach in past commentaries.  Why no update on seasonally adjusted unemployment?

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

• Focus on net job creation.  This is the most important.  The big story is the teeming stew of job gains and losses.  It is never mentioned on employment Friday.  The US economy creates over 7 million jobs every quarter.
• Failure to recognize sampling error.  The payroll number has a confidence interval of +/- 105K jobs.  The household survey is +/- 450K jobs.  We take small deviations from expectations too seriously -- far too seriously.
• False emphasis on "the internals."  Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy.  In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
• Negative spin on the BLS methods.  There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment.  This is a propaganda war that seems to have ended years ago with a huge bearish spin.  For anyone who really wants to know, the BLS methods have been under-estimating new job creation, which was demonstrated in the addition of 350K additional jobs in the benchmark year.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

And most importantly, it would be helpful if anyone would realize that the BLS is just one estimate among others -- and perhaps not the best.  The bean counter example illustrates this.

Trading Implications

In my experience it has usually been safe to be conservative in front of this report. The story is so complex that it is pretty easy to generate a negative spin. Your favorite perma-bear/conspiracy site does a good job of preparing. It is poised to comment on seasonal adjustment, birth/death adjustment, labor force participation, hours worked, and discrepancies between the payroll and household surveys.

Here are some fearless forecasts from the Old Prof:

• Based upon my indicators, I am especially worried about this month's report.
• Much will be made of seasonal adjustments - - mostly by those who have never produced a dataset that included any seasonal adjusting!
• No one will recognize that the BLS estimate is just that --- an estimate. We already know most of the answer, and it is pretty good.
• Any extreme result will get an exaggerated interpretation. If the job growth were to be 50K, we will have claims that recession is upon us. If the BLS estimate is 300K, we will hear that the Fed is about to tighten rates!
• Watch the "hours worked." This could be an early indicator of employment weakness.

As usual, the number is less important than everyone thinks. So here is the most important point:

The Fed will not change policy based upon the March employment report—no matter what the outcome. Everything that I have written here is completely understood by the FOMC. It will take a long series of results to influence Fed policy. Since traders and pundits do not seem to grasp this, the wise investor may get (yet another) opportunity.

Weighing the Week Ahead: Signs of another Economic Soft Patch?

With each new week, there is a fresh challenge to the most-hated market rally. Last week it was Cyrpus. As I have suggested over the last two weeks in the WTWA series, this issue created volatility that provided opportunities for both traders and investors.

This week I predict that attention will focus on possible softening in economic data and concerns about seasonal market effects. The "sell in May" contingent has their own version of Daylight Savings Time! They now recommend selling in April.

Will economic data show springtime weakness?

David Rosenberg, the favorite economist for the bearish community, has a fresh take on his personal recession odds:

"If in fact we avoid a fiscal mistake, then the risks of a recession go down sharply (some Fed district banks peg the odds at a mere 6%) and what we are left with is what we have had all along, which is a muddle-through post-bubble deleveraging economy..."

Rosenberg's biggest concern is a "fiscal mistake" -- meaning that the immediate focus on the deficit would be too great.

I have some thoughts about the seasonal threat 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 regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world.

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:

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

The Good

There was some encouraging data, but the overall story included both good and bad elements.

• The inventory of foreclosure sales is down 19%. (CoreLogic via Global Economic Intersection).
• Tax receipts and deposits are back to the old highs on a trailing twelve-month basis. See the interesting chart from Ed Yardeni:

• Cyprus contagion was avoided and lines at banks were orderly.
• Michigan consumer sentiment made a strong and surprising rebound to 78.6 in the final report. See Doug Short's discussion for a look at my favorite chart of sentiment. He also has the Conference Board version, which tells a different story. There are many factors at work here, but the overall story is relevant for consumption and employment.

The Bad

There were several negatives in a mixed week for economic data. Bespoke notes that the pattern over the last two weeks has been for results to miss expectations, which have perhaps gotten a bit too high. Check out their helpful summary table.

• Initial jobless claims were a bit worse than expected, as was the four-week moving average. This chart from Steven Hansen is part of his most recent summary of economic conditions, which he sees as slowly improving. The initial claims chart provides an interesting focus on the last three years.

 

• Flash PMI's for the Eurozone continue to weaken. Markit publishes these a week or so before the official numbers. See Global Economic Intersection's report for a graph showing the tight fit to GDP.
• The Chicago PMI was very weak – a bad sign for next week's ISM report.
• Negative earnings pre-announcements have hit a seven-year high. See Josh Brown's analysis of FactSet data and this chart:

The Ugly

North Korea announces a state of war. NPR notes that the chances for miscalculation have increased:

Analysts say a full-scale conflict is extremely unlikely, noting that the Korean Peninsula has remained in a technical state of war for 60 years. But the North's continued threats toward Seoul and Washington, including a vow to launch a nuclear strike, have raised worries that a misjudgment between the sides could lead to a clash.

In Washington, the White House said Saturday that the United States is taking seriously the new threats by North Korea but also noted Pyongyang's history of "bellicose rhetoric."

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 well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively. In the past, most recently October, 2011, 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.

As part of the weekly indicator snapshot I emphasize the best methods for forecasting recessions. For the last eighteen months this has focused on the erroneous ECRI recession claim. For some reason, the main financial media do not give adequate recognition to any of the sources we follow, preferring to feature the ever-changing ECRI story.

If you have followed the sources I recommend, you have done well. Let us summarize their work.

I 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.  Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine's latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong. His latest article questions the use of M2 as part of the ECRI's WLI.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now eighteen months old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating --- now reflecting the most recent personal income data.

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.  A few weeks 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 an avalanche of data.

The "A List" includes the following:

• Employment Situation Report (F). This report is probably the most important in the eyes of the market. I disagree with this emphasis, but I respect the reality.
• Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator, even more than the monthly payroll report.
• ISM index (M). A good concurrent indicator for the overall economy and a helpful predictor for employment.
• ADP private employment (W). This source has been even better than the official measures in recent months, although many disagree.

The "B List" includes the following:

• ISM services (T). The service sector may be more important than manufacturing, but this data series has a shorter history.
• Factory orders (T). Important, but not as timely since it is February data.
• Trade balance (F). Improvement here helps GDP. The results have attracted more attention as US energy exports have grown.
• Consumer credit (F). Anything related to consumer spending is of special interest right now.

Also – I'll be watching for any earnings pre-announcements.

Trading Time Frame

Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks.  Felix has been long, but in cautious sector choices. At one point we had reduced to 1/3 long in trading accounts. The overall ratings are strong enough for us to be fully invested, but there was a decline over the last week.

I discuss the daily changes from Felix at Wall Street All Stars, where we have a vibrant community with many good ideas. Subscribers can also get answers to questions from several different great sources. My weekly Felix update is usually restricted to subscribers, but I have opened it up for last week. The list is a good source of ideas about what sectors are working. You can also look at the top names in that ETF. I also frequently mention Felix's favorites among the NASDAQ 100 stocks.

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."

Investors who have been underinvested in stocks wonder if it is too late to invest. Those who have enjoyed the current rally are bombarded with warnings about the need to sell.

I do not see this year's current gains as a game changer for the market, and the hoopla about the new record highs is also a distraction. The early move this year mostly reflected an unwinding of fear in front of the fiscal cliff decision. I explained my rationale and emphasized the need to be flexible in adjusting your price targets in this article. The post highlights the reasoning of many analysts who have updated the market prospects rather than remaining locked into a concept created in December.

I also like the assessment from fellow Seeking Alpha contributor Alan Brochstein, Up 10%, Are Stocks Now too Dangerous to Hold? He touches all of the bases in his answer to the key investor question – market valuation, overheated sectors, the profit margin issue, interest rates, and even some technical analysis. There is no good way to summarize this excellent overview article, so I encourage you to read it.

I invite you also to review my 2013 preview for Seeking Alpha.  This covers some key investor catalysts, as well as 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 – a conservative, yield-based approach.

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).

Final Thought

Markets always have corrections, but predicting the timing is not that easy. Some expected the year to start off with a correction, so they are now 10% behind. Others advocate selling in May. Most would be surprised to learn that stocks usually make gains between May and October. The gains are smaller, but it is not a time where short selling would necessarily be profitable.

It is much better to consider the specific circumstances than to rely on simply trading rules and slogans. What should we expect right now – from the economy, from corporate profits, and from stocks.

The economy continues a slow growth path with little threat of recession. The Bonddad Blog notes that if you look at the economy as measured by real Gross Domestic Income (GDI) instead of GDP, the Q4 rate of growth was 2.6%, much stronger than the final GDP estimate of 0.4%. Why use GDI? The ECRI insisted that it was the better measure back when it served their purposes. Whatever the measure, Q113 is shaping up to be stronger.

Corporate profit forecasts are improving in line with the economic expectations. Brian Gilmartin has an extensive review of this question, including treatment of specific sectors.

Stock prices in most sectors reflect plenty of skepticism. The new records have been driven by a stampede into anything with a coupon or a dividend. Most investors seem not to grasp the danger of this approach, so we can expect to see some rebalancing from bonds to stocks and from defensive sectors to the lagging sectors of technology, cyclicals, and financials.

And finally, take a look at Jeff Kleintop's list of ten indicators to watch. They overlap with many of those in our weekly list, but he highlights the group as providing a good warning last year. This year only two of the ten are flashing a warning – so far!

Bad Reasons for Avoiding Stocks

There is a broad group of individual investors who are completely out of stocks or significantly under-invested.  Many were paralyzed by fear in the time after 2008.  They have still not returned to investments in stocks.

This is a natural and normal reaction to risk.  People fear losses more than they crave gains.  This natural human trait causes most investors to do exactly the wrong thing at the wrong time!

There are multiple sources of fear, but the current theme is that it is too late for this year.  If you have not been invested, you have missed the rally for three reasons:

1. The market has already made most of its gains for the year, getting close to the targets of the most bullish of prognosticators;
2. The move has been too far and too fast;
3. The time of seasonal weakness is upon us.

Let us focus on the first of these reasons – the price target.

Why We Need Moving Targets

Here is an idea that can liberate investors:

Ignore calendar year market forecasts!

If you are looking for an investment edge, here it is.  Most people analyze portfolios based upon the calendar.  World events march to a different drummer!

This year is a great example.  The annual forecasts were done at a point when everyone was worried about the fiscal cliff, a downgrade of US debt, an imminent recession, and a hard landing for China.  When this did not happen, (an eleventh hour result that I predicted), the market rallied about 6%.

Suppose that you missed that rally.  Should you pretend that the facts did not change?  Should you remain anchored to your December, 2012 forecast?

Or should you adjust your thinking to reflect new evidence?  Just suppose that the fiscal cliff issues had been resolved in November, 2012.  We would have started 2013 from a higher level.

My Method

I have a personal method that has worked well for more than a decade:  I use a rolling twelve-month forecast.  I do this for individual stocks and also for the market.  I refuse to be chained to the calendar.

When the underlying data change, so does my price target.  The calendar does not matter.  My thinking is flexible, taking what the market is offering.

Some Agreement from The Street

I am surprised and pleased to see that some top analysts are recognizing the need for more frequent reviews of their price targets.  Instead of going with the knee-jerk reaction, please give some careful attention to these analysts, who see S&P targets as high as 1760 for this year:

There are others in the club.

As background, Bespoke noted more than a month ago that the rally was approaching the Street targets - check the chart and commentary.

Goldman Sachs boosts from 1575 to 1625.

Morgan Stanley's bearish Adam Parker boosts to 1600.

These are all analysts who  recognize that circumstances have changed since the time of their original forecasts.  This is in sharp contrast to what happened at the end of last year, when analysts stubbornly held to foolish forecasts.

Investment Implications

This is one of the easiest ways for the average investor to get an advantage over the big-time sell-side forecasts.  Most data sources provide earnings for a calendar year.  Here at "A Dash" I try to do better by finding the best sources.

Isn't it obvious that a rolling one-year forecast is better than locking into the calendar?

If you had the data, you would do it.  I often provide such information.  I get it from Brian Gilmartin, and occasionally Ed Yardeni. 

I explain to all of my new investors that even good years will include a correction of 15% or so, regardless of the fundamentals.  I cannot time these and neither can anyone else.  It just comes with the territory.  Develop and stick to your forecast.

Looking at the long-term fundamentals is the key to long-term success.  There are many stocks trading at significant discounts based upon current earnings.  These can often be found via Chuck Carnevale's first rate web site.

Some current favorites from assorted sectors are AFL, CAT, and JPM.

I will try to elaborate further on this theme, but this installment is timely.

Weighing the Week Ahead: More Opinions, Less Data

Sometimes the weekly calendar does not provide much fresh data. This has no effect on the need for content on the part of financial media. Blank pages and air time must be filled.

The result? A bull market in opinion --- data not required.

The economic data have been pretty consistent – low inflation, consistent but weak growth, and some bright spots, especially in housing.

The policy implications have also been clear – a Fed determined to emphasize the employment side of the dual mandate.

None of this provides much zest, especially since there is little change in the story. The way to spice it up is to find some extreme opinions and get an argument going. My prediction is that this week will see a more varied media lineup, with riffs on the following themes:

1. New market top. Has the move been too fast, too far? Is it justified?
2. Stagflation. I resisted putting this in the title. I notice that it is popular with readers, so the topic is a Twinkie-style sugar high. The story comes in two parts:
   1. Some will emphasize the "Stag" with another recession salvo from the gang at the ECRI. While the measures keep changing, they seem to command media attention. Too bad that the recession truth squad does not get equal time.
   2. Some will emphasize the "flation" by claiming that government data are wrong.
3. Fed Manipulation. Yet another group will explain that this is a "training wheels" rally based upon a "sugar high" and warning that it will all end badly.

And that is my prediction – a week of opinion fluff instead of real information.

As usual, I have some thoughts about how to navigate these waters, 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:

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

The Good

This was a pretty good week for the economic data and market news.

• Sentiment indicators have declined. This is bullish on a contrary basis. See Bespoke for a discussion of this chart – only a sample of their popular daily product.

• Household net worth hit a new high. I am scoring this as "good" but it was not a market moving event. (See the Doug Short take below).
• Employment growth is good, especially in the wake of the "fiscal cliff." Remember the worry on this story? There were many effects at year-end, so it will take some sorting out. Dr. Ed Yardeni thinks that there was plenty of negativity built in at the end of the year. Despite the end of the payroll tax reduction, the overall impact is positive. So far he seems to be right. The market had a modest positive reaction to the news. (Some dissent in 'the bad' below).

• Obama meets GOP rank and file – away from the White House. Hey! It can't hurt. Even Leader Boehner seemed on board with the initiative. The President's poll ratings have been plunging, so that may provide some incentive to compromise.
• Gas Prices moved lower – but there is still a long way to go.
• The ISM Services Index hit a 12-month high. See Steven Hansen's story at GEI for the details. Take a look at the full table of sub-components and the comparison with the ISM manufacturing index.

The Bad

The data for this week seemed pretty good on the surface, but there were issues if you took a deeper look.

• Progress is inadequate, even as wealth rebounds. This is probably the single most important observation about the US economy. Doug Short's first-rate analysis of the net worth data, including all of the charts you would expect, shows why we still lag what is needed for solid economic improvement. There are many great charts, but this is my personal favorite. The growth has resumed, but we still lag the overall trend.

• The Fed's biggest asset (surprise!) is student loans. Without going into many complex policy details, I suspect that most share my sense: This has a bad feeling to it. Doug Short has the data and a great chart.

• The unemployment rate. The headline stated that unemployment was down by 0.2% percent. Most analysts know better. This headline number is a combination of the number employed and the size of the labor force. Even when employment is better, the labor force shrinkage has been a major factor in the employment rate calculation. Calculated Risk has a fine post discussing this topic, and including excellent charts. Here is an example:

Bob Dieli's monthly employment report for his clients points out that the only true improvement in the unemployment rate over the last several months came last September. Other examples reflect changes in the labor force. (Check with Bob and mention us for a free sample).

• Assorted Europe stories, mostly repeating the known economic weakness. I am taking note of this, but none of the market indicators suggest that this is really fresh news.
• PE Ratios Edge Higher (via Bespoke). Most people will see this as a valuation negative, so that is where I have placed it. See the article for a helpful chart. Regular readers know that I expect the multiple to increase along with better confidence about the economy, so the interpretation is open to debate. See also Brian Gilmartin's tracking of forward earnings and the equity risk premium: "Assuming a 5% 10-year Treasury yield, the SP 500 would still need to increase 48% from its current level ($112.39 divided by 5%) to bring the SP 500 into parity."

The Ugly

The state of knowledge – for both traders and investors. Most market participants do not want to be confronted with reality, but you can do this in private. Here are two quizzes on important topics. Both involve the interpretation of data. I had a very low score on one of them and a very high score on the other. Feel free to report your own scores and observations in the comments.

1. The ZH Test (via Cassandra at Ritholtz.com). I cannot improve on the introduction to the test, which everyone should take, if only for a laugh:

"Being permanently bearish on equities definitely pays.

Just ask Zero-Hedge. Unfortunately, for wool-dyed pessimists and the other overly-skeptical black sheep of the thundering herd, it pays apocalyptic newsletter writers' paychecks, and Zero-Hedge/Tyler Durden's Manhattan bar tabs rather than those who permanently position against market priapism. And it's worse than zero-sum because those who are optimistically-challenged often pay for the bad advice – whether directly in subscriptions, inflated margins on retail bullion products, or indirectly via page-views and click-throughs AND then they get hosed by the market.

The first step to improving behaviour toxic to one's own self interest is admit one has a problem. As an aid to help those who have difficulty in distinguishing "a bearish trade" from "the lead boots of anger and pessimism", I've devised a little something I call the Zero-Hedge Test to determine more precisely whether readers objective realities are sufficiently  paranoid, pessimistic, anti-social and rantingly angry to warrant more serious help."

1. The labor force participation test. The WSJ's Real Time Economics Blog does a great job with this. They take a topic of great importance, cited by everyone, and illustrate why the basic understanding is rather poor. In a perfect world every pontificating pundit—everyone discussing labor force participation -- would have his score on this test reported along with his opinion. I invite readers to suggest their own disagreements with the BLS definitions – which seem fairly reasonable once you grasp the principles.

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.  Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. Dwaine also notes that recession has struck in many countries around the world—monitoring many of the OECD countries here. Take a look!

Georg Vrba is a great "quant guy" with great credentials a variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong.

New Deal Democrat, writing at The Bonddad Blog, does an in-depth analysis of the latest ECRI story. The metrics change in a way that "cherry-picks" old data. Read the elusive story for yourself.

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 notes that the original ECRI call was basically a "bet against the Fed." At the time they claimed that there was nothing that anyone could do. Has their story changed? You really need to read Doug's article to get the full scope of the disparity in forecasts. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

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.  Recently we switched to a neutral position.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings have stabilized and improved significantly this 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 continue to have less confidence in the overall ratings.  [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 is rather light on important data.

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.
• Michigan Consumer Confidence (F). I treat this as more important than do others, mostly because our team's research shows it to be important. I see it mostly as a good confirming coincident indicator, important for consumer behavior and also for a read on employment.

The "B List" includes the following:

• Retail Sales (W). The data provide an important read on the consumer (somewhat redundant with private same store sales reports), especially given the end of the payroll tax relief and higher fuel prices.
• PPI (Th). Expectations are benign, making this report less interesting.
• CPI (F). See PPI.
• Industrial production (F). An important factor in the GDP/recession calculation.
• JOLTs Report (T). This report shows job turnover and actually provides a lot of data unknown to most. It does not get much attention, and when it does, the interpretation is soft. A good topic for a future story.
• Business inventories (W). Relevant for GDP revisions.

I am little interested in further revisions on elements of Q4 GDP, and the market will not be either. There are some retail earnings that might attract notice, but it is generally a quiet week. I also care little about regional Fed surveys.

Trading Time Frame

Felix has switched to a marginally bullish posture. It has made a slight difference in trading accounts. It has been a close call for several weeks.  When the model turned to neutral, we dropped to 1/3 long. Since the sector was consumer staples, it was still a conservative call. We increased exposure this week in a second conservative sector. Felix has turned bullish, but it is like dipping a toe in the water.

Last week it looked like Felix might switch into an inverse ETF, but that now seems unlikely. Unlike human traders, Felix responds to data, not headlines. Felix also does not anticipate – requiring actual evidence for action.

Felix did pretty well last 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.  Felix has been cautious, but still has caught most of the rally, and done so 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."

Warren Buffett spent a few hours on CNBC's Squawk Box last week. As regular readers know I use TIVO and mute to find the best stories from this source. CNBC helped with some highlights – only nine well-spent minutes and you can see the best of the Buffett advice.

I was struck by this comment. Mr. Buffett said that the market offered you a quote on your holdings every day. This should be an advantage, but most people made poor use of it by trading at the wrong times. They would be better off to check on their portfolio every five years or so! It explains why most people make big mistakes in trying to time the market.

So do most "experts." I exposed the false claims of many pundits. You can check out the overall issue and also pundit ranks by reading The Seduction of Market Timing.

While there are no miracles available from market timing, you can definitely improve your risk/reward balance.

I strongly believe that active management can help investors. My concepts emphasize limiting risk and finding the right themes, not trying to time the markets via watching headlines. I really tried to pull this together in my 2013 preview for Seeking Alpha.  This covers some key investor catalysts, as well as 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.

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).

Final Thought

Whether you are a trader or an investor, you have done best to remain open-minded over the last four years. The warnings have not changed, but the facts have.

If you have not been reading and watching Downtown Josh Brown, you are missing out on some very frank and objective analysis.

Here is his take on the four-year anniversary of the market rally:

"Today, in case you've lost track, is the fourth anniversary of the March 9th "Generational Bottom" for the stock market. We are now headed into the fifth year of what many of us have been calling "The Impossible Rally" and I thought this would be a good time to recap and reflect.

Today, four years ago, the Dow Jones industrial average lost 80 points, or 1.2%, to end at 6,547.05, its lowest point since April 15, 1997. The S&P 500 index lost nearly 7 points or 1%, to end at 676.53, its lowest point since Sept. 12, 1996. The Nasdaq composite lost 25 points or 2%, to end at 1,268.64, its lowest point since Oct. 9, 2002.

That day, Merck had announced a $41 billion acquisition of its rival drug maker Schering-Plough and the market didn't even blink. It had been going down so hard and for so long at that point that no one believed it would ever go up again.

That morning Roubini and Faber were out doing their typical Gloom and Doom show, scaring the wits out of anyone who would listen.  One was talking about an intensifying recession with no way out, the other predicted the S&P would be dropping below 500 by year's end. The opposite ended up happening, of course."

This is now in the past, of course, but the principle remains the same.

The Capital Observer notes that there are plenty of lagging stocks – mostly in cyclical and technology names. That is where I am buying as well.

February Employment Report Preview

This month's report is especially important. I am cautious for several reasons:

1. The market rally is generally perceived as extended – many are looking for a reason to sell;
2. The story is complex, with many spinning angles;
3. There is a ceiling on strength, due to incorrect assumptions about the Fed.

I will elaborate in the conclusion, but let us first review the expectations for Friday's report.

Background

For many years I have written a regular monthly preview of the Employment Situation Report.  I have done extensive research on all of the methods and even visited the stat guys at the BLS to discuss their approach.

My preview gives appropriate respect to the BLS, but also to the leading alternative methods.  My best analogy was to a bean-counting contest.  The winner was NOT the contestant who was closest to the correct answer.  Instead, the winner had to predict the guess of a fellow contestant.

This is what we do every month.  We want to know the truth about the economy.  Instead of recognizing that there are several good estimates, everyone tries to guess what the BLS will report.

Please read the September preview both for a laugh and a deeper look.

Last month I did something extra, reviewing the most recent period for which we have actual data and showing who had the best estimate. There were three conclusions:

• All of the estimates were too low.
• The much-maligned ADP was the best, and that missed by more than 100K jobs.
• The BLS methods were the worst.

We rely too much on the monthly employment report.  It is a natural mistake.  We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.  Whenever there is an important question, we all seize on any available information.  While we might know the limitations of the data, any concern is briefly acknowledged -- if at all -- and then swiftly put aside.

The Data

We would like to know the net addition of jobs in the month of February.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

1. An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
2. The report is revised to reflect additional responses over the next two months.  This is especially important this month since the official survey response date has been moved forward by a week.  This is a routine adjustment for the Thanksgiving holiday, but it increases the potential for error and later revision.
3. There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone. Everyone focuses on the birth/death adjustment. This actually accounts for less than 20% of the BLS attempt to estimate job creation.
4. The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low, as revealed in the most recent report.  For the year ending in March, 2012, the BLS estimate was off by about 30K jobs per month overall, and 35k jobs per month on private employment. The January report adjusted for these benchmark revisions.

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer.  The BLS is actually like one of the contestants, with the full report coming later.  The market uses this estimate as "official" and declares winners and losers on that basis.  No one pays any attention to the final data, which we do not see for eight months or so.

• ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 198K private jobs on a seasonally adjusted basis.  In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate.  In recent months ADP is using an improved methodology with a stronger sample.  The objective is to improve the correlation with the final print of the employment data. 
• TrimTabs looks at income tax withholding data. Their idea is that this is the best current method for determining real job growth.  TrimTabs forecasts a gain of 100K. There was a lot of year-end uncertainty about tax law from the fiscal cliff debate. TrimTabs has wisely taken note of this and is trying to adjust for the changes in tax withholding.
• Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).
• Jeff Method.  I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines, but it is a high priority summer project.  It remains difficult to account for the effect of headlines about politics, the sequestration debate, and the end of the payroll tax relief. None of these factors relates to employment, so there is more noise than signal right now. Layoffs catch the headlines, because these are big visible chunks of jobs.  I do not think we have a good grasp on job creation.  The BLS tries hard, but their approach lags on this front. Street estimates are generally similar to my method, but few reveal much about the specific approach.  These estimates usually adjust for the ADP report.
• Briefing.com cites the consensus estimate as 178K, while their own forecast is for 180K.  Their private jobs forecast is about 15-20K higher, since the loss of public jobs is a continuing drag.
• Gallup does not seem to have an update to their unemployment series. I have tried to give this source respect and equal time despite a rather overt bearish and political approach in past commentaries.  Why no update on seasonally adjusted unemployment?

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

• Focus on net job creation.  This is the most important.  The big story is the teeming stew of job gains and losses.  It is never mentioned on employment Friday.  The US economy creates over 7 million jobs every quarter.
• Failure to recognize sampling error.  The payroll number has a confidence interval of +/- 105K jobs.  The household survey is +/- 450K jobs.  We take small deviations from expectations too seriously -- far too seriously.
• False emphasis on "the internals."  Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy.  In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
• Negative spin on the BLS methods.  There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment.  This is a propaganda war that seems to have ended years ago with a huge bearish spin.  For anyone who really wants to know, the BLS methods have been under-estimating new job creation.  This will be reflected in the January report, which will show over 350K additional jobs in the benchmark year.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

And most importantly, it would be helpful if anyone would realize that the BLS is just one estimate among others -- and perhaps not the best.  The bean counter example illustrates this.

Trading Implications

In my experience it has usually been safe to be conservative in front of this report. The story is so complex that it is pretty easy to generate a negative spin. Your favorite perma-bear/conspiracy site does a good job of preparing. It is poised to comment on seasonal adjustment, birth/death adjustment, labor force participation, hours worked, and discrepancies between the payroll and household surveys.

Here is an experiment. Check out what they say right after the number is reported and also note Rick Santelli's initial reaction on CNBC. Then follow Santelli for the next 30 minutes. He will get the message and report it.

Some might think of it as the "Santelli call" which would be the opposite of the "Bernanke put." It might only work for a few minutes, but that is long enough for shorts to cover.

I am also concerned about the ISM reports. While these have been very strong, the employment components have been weaker.

Here are some fearless forecasts from the Old Prof:

• Much will be made of seasonal adjustments - - mostly by those who have never produced a dataset that included any seasonal adjusting!
• No one will recognize that the BLS estimate is just that --- an estimate. We already know most of the answer, and it is pretty good.
• Any extreme result will get an exaggerated interpretation. If the job growth were to be 50K, we will have claims that recession is upon us. If the BLS estimate is 300K, we will hear that the Fed is about to tighten rates!
• Watch the "hours worked." This could be an early indicator of employment weakness.

As usual, the number is less important than everyone thinks. So here is the most important point:

The Fed will not change policy based upon the February employment report—no matter the outcome. Everything that I have written here is completely understood by the FOMC. It will take a long series of results to influence Fed policy. Since traders and pundits do not seem to grasp this, the wise investor may get (yet another) opportunity.

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:

1. By definition, a former top failed. That is how it got to be a top!
2. 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:

1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
2. 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.

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).

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.

 

Weighing the Week Ahead: Is the Housing Rebound for Real?

 

Has housing bottomed? For real?

The question has special significance because the consensus economic forecast assumes improvement in this sector. This week's economic data include the most important reports on the housing market. The FOMC minutes will also provide insight into Fed policy on the purchase of mortgage securities. With Congress on an extended President's Day recess, I expect housing to be the theme of the week.

The Background Evidence

On the positive side there is the evidence of the market. The iShares Dow Jones Homebuilder Index shows the dramatic rally since June, 2012 – about 85%. The gains have been supported by commentary from executives at the major industry leaders and the top real estate publications. For many, it creates a sense of déjà vu.

Some pundits have called this quite accurately, including Schwab's Liz Ann Sonders. In an interview with TheStreet.com she opines that we are still in the first inning.

On the negative side we have Yale Professor Robert Shiller, widely acclaimed for predicting the housing bubble. Dr. Shiller is also the co-founder of a licensed home price index and also a sector based ETN using his methods.

In two recent interviews he makes the case for caution.

• Housing is not a good investment vehicle, when adjusted for inflation, maintenance costs, and technology improvements. (Via Sam Ro coverage of a Trish Regan interview).
• Overall optimism is too premature. In an interview with Henry Blodget at Business Insider, Dr. Shiller carefully distinguishes himself from an unnamed "perma-bear guy." Here is a key response:

  Blodget: So what is your sense of the next five years? Do you think we've hit bottom in the housing market or do you have to stratify it that way?

  Shiller: I think that we might have [hit bottom], but my biggest sense is that probably nothing dramatic happens either way. If the Pulsenomics survey is right, and it's up between 1 and 2 percent real, that's plausible to me. But also down 1 or 2 percent real, that's plausible. I'm sorry I don't have a more precise forecast.

Which approach is more plausible? Has housing bottomed? What does the answer mean for the individual investor? As usual, I have some thoughts on this question 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:

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

The Good

This was a good week, both for data and for earnings. 

• Retail sales were pretty good (see Steven Hansen at GEI for the full story).
• Housing inventory is down 16%, y-o-y. And yet another survey shows prices higher. (Both via Calculated Risk).
• Weekly jobless claims dropped to 341K, well below expectations.
• There is a U.S. budget surplus! Let us not get carried away. John Lounsbury shows the reasons behind the one-month surplus, an artifact of law changes and timing. The overall deficit picture is improving, as this chart from Scott Grannis shows:

• Earnings and revenue beat rates have been strong. Here at "A Dash" we report on earnings whether good or bad. Many sources always take the negative side. They suggest that earnings estimates are always too optimistic. They later say that the "bar was set too low." More recently some have argued that you must ignore earnings and look to revenue. Even by that standard the Q412 earnings season has been strong. Here is the chart from Bespoke showing the revenue beat rate. The full article has several more excellent charts and additional analysis.

• M&A deals are at a new peak, healthier than those in the past, indicating solid value. Check out the powerful commentary from Josh Brown, explaining why this is the Healthiest M&A Boom in Decades.
• A new source for accountability. PunditTracker lets you nominate pundits and predictions, assign grades, and follow the scores. It is a bit early to judge, but the current returns are still interesting.
• Michigan sentiment posted a solid rebound. Here is my favorite chart of this indicator via Doug Short:

 

 

The Bad

There was some bad news, especially on the political front.

• Industrial production declined 0.1% in January versus an expected gain of 0.2% or so. New Deal Democrat points out that the story was not all bad. There were significant revisions to the November and December reports. With the revisions included, the overall level is actually better than expected. (See also Doug Short in the indicator update below).
• Earnings growth estimates seem too optimistic. Check out this chart from Eddy Elfenbein and see his analysis:

 

• The sequester is coming. The State of the Union speech did not bridge the gap. The Democratic Senate proposal is a non-starter. No one on either side is upbeat about an eleventh-hour solution. Meanwhile, Congress voted to recess until February 25^th. But don't worry. In the wake of last week's asteroid news, House Committee hearings are already planned!
• The end of the payroll tax cut is hurting retail sales. A leaked email from a Wal-Mart executive suggests that February sales are terrible. This hit both retail stocks and the overall market on Friday. Higher gas prices add to the concern.

The Ugly

Suspicious trading in Heinz options suggests that someone had advance information. A level playing field is important for investor confidence, so this deserves SEC attention. Paul Vigna's story reports how the SEC is freezing the Swiss trading accounts involved and also acting to determine who is involved.

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 average investor has lost track of this long ago, and that is unfortunate.  The original ECRI claim and the supporting public data was 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 abbreviated trading week brings some interesting data.

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. Weather effects will complicate our interpretation.
• Leading economic indicators (Th).  This is still a favorite for some.
• Building permits (W). My favorite leading indicator for housing.
• FOMC minutes (W). The market is (mistakenly) poised for any fresh news about the Fed.

The "B List" includes the following:

• PPI (W). Expecting little, but important if perceived as a change in the trend.
• CPI (Th). Expecting little, but important if perceived as a change in the trend.
• Housing Starts (W).  This is a key element of the economic rebound, so it is important to follow.
• FAFA home prices (T).  These are the prices from the regular homes in the government market.

It is the open period between Fed meetings, so there will be plenty of speeches, especially on Thursday.

Trading Time Frame

Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks.  Felix did pretty well last 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.  Felix has been cautious, but still has caught most of the rally, and done so 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.

Prof. James Hamilton has a great post explaining your choices: "The question is maybe not what is a good investment right now, but instead what is the least bad investment." He writes further as follows:

But what else are you going to do? Low as the dividend yield is on stocks at the moment (2.04%) , it's still better than what you can get on a 10-year U.S. Treasury bond. Moreover, any inflation in the prices of the goods and services that firms sell, as well as any profit gains associated with a larger market, should boost those dividends over time, whereas inflation would continue to erode what you make on the Treasury. Or you might look at a Treasury Inflation Protected Security, whose coupon will rise with the headline CPI. That's currently yielding a hefty -0.57%. Anybody want to sign up for that 10-year plan?

High-yield bonds are dangerous, partly because of the stampede for yield. (Formerly referred to in my series merely as the Quest for Yield). David Schawel (in an article highlighted for us all by Abnormal Returns), writes as follows:

Greater price risk now exists: The devil is always in the details, and price is an important risk that most corporate bond investors, in my opinion, are overlooking.

Gold is currently on a "sell signal" according to Georg Vrba, whose technical model follows the Coppock indicator.

The last sell signal was at the end of November 2012 and no new buy signal has so far appeared. What is needed now for an early buy signal is a sustained upward move of the gold price to over $1,700 during the next few weeks, something which is certainly not outside the bounds of probability.

Meanwhile, we have continuing "headline risk." Buying stocks in times of fear is easy to say, but so difficult to implement.  The big-shot experts on TV are calling you the dumb money, even when you have been right! (in case you missed it, see this discussion).

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." For many, the big shift is on.

Scott Grannis provides a useful chart of fund flows and writes as follows:

This follows six years during which equity funds experienced huge and almost relentless outflows. Has the tide finally turned? Are investors now finally becoming bullish after four years of strong equity gains? Perhaps, but if this is the beginning of the return of bullish sentiment, it likely has a long way to go before it runs out of gas.

This can all seem confusing for the individual investor. To help, I have collected some of my 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).

Final Thought

Do we have a bottom in housing? This type of question is very dangerous. It raises a topic that we all think we know about and we all have an opinion. We are tempted to substitute what we see in our neighborhoods (relevant but not decisive) for actual data. Things are looking pretty good in my town, but I would like to know more. I recognize that I am not an expert on housing. I am an informed consumer of the reports of housing experts. So are you, whether you realize it or not!

When I look for expertise, I have three paramount thoughts:

• Is the information something that can create value in my investments?
• Does the source change conclusions with the evidence?
• Are the changes timely?

I have occasionally been accused of credentialism in favor of academics and degrees. I object, since I seek the best information from all sources. Sometimes this means that I regard the world's leading experts on monetary policy at the zero bound as superior to some bloggers who are "self-taught in Austrian economics" (the most dangerous words in the investment lexicon). On this occasion I suggest that Dr. Shiller is failing on all three counts. His work is solid by academic standards, but it is much too slow to change and essentially not profitable for investors.

John Paulson was timely in spotting the housing risk. He has a new viewpoint.

Bill McBride at the Calculated Risk blog earned the respect of everyone, including leading economists. This recent feature in the Los Angeles Times tells you what you need to know.

From our perspective, he meets the key tests:

• He told us that the "Housing Bottom is Here" a year ago.
• He follows inventory carefully, remaining skeptical of industry sources.
• He understands the big picture, showing how housing spills over into the general economy.

Investment Conclusion

The housing stocks are too rich for me, although we have sometimes held ETF positions in the Felix portfolio. My current focus is on the implication for the overall economy. The story continues to be both important and positive. Housing has been a multi-year subtraction from the economy. Even a modest rate of growth represents a major change with implications for consumers and employment. This helps to explain the spending and sentiment strength, even in the face of the payroll tax change.

Weighing the Week Ahead: Hope for a Budget Compromise?

Sometimes the week ahead, despite our relentless focus on markets, brings policy issues to the fore. Such was the case during the fiscal cliff countdown, and it is happening again.

Here at "A Dash" I have strongly advised that investors remain agnostic about politics. It is more profitable to accept the reality of current policy. Figure out what investment is best for the times. For this reason I rarely opine about policy. I often identify what is most likely to happen, and which outcomes are market-friendly.

In this spirit I suggest that investors should be monitoring the slow and laborious process toward a compromise that will avoid the impending spending sequestration. Until now I have refrained from writing about this issue. Why this week? Two things.

1. It will be a light week for other economic data, leaving plenty of media space and time to fill. My mission in the WTWA series is to forecast what will be on the agenda.
2. The State of the Union speech might offer some real hints -- if you know what to look for.

Background on the Sequestration Issue

Sequestration was adopted originally as part of the resolution to the 2011 debt ceiling impasse. The Budget Control Act of 2011 (Congress is great at misleading names for bills!) created a Congressional Joint Committee on Deficit Reduction. This "SuperCommittee" was evenly balanced, and failed to reach a bipartisan agreement within the time limit. Congress has acted to delay the implementation of these cuts, most recently as part of the so-called "fiscal cliff" resolution. D-Day is now March 1^st, but the effects are already being felt in many ways.

While some now seem willing to allow sequestration provisions to take effect, no one really believes that the meat-axe approach is the preferred solution to U.S. budget problems. In fact, the original intent was exactly the opposite.

The issue is important. The automatic cuts will reduce expected economic growth by 0.7% according to the Congressional Budget Office. This will have a related effect on expected corporate earnings.

The timing is important, since Congress is about to go on an extended "President's Day Recess" starting Friday.

Background on the State of the Union

President Obama's second inaugural address was widely perceived as aggressive and partisan. The tradition for the State of the Union Address is different. While it lays out an agenda, it often strikes some bi-partisan and patriotic themes. It will and should be closely watched as a hint for the future. There are some preliminary leaks about the text, but even these may be trial balloons.

I have some thoughts on what to watch for in the SOTU speech 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:

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

The Good

This was a generally positive week, both for data and for earnings. 

• The outlook for profit margins is promising in the eyes of most analysts. Sam Ro of Business Insider show the consensus take and highlights the dissent from Goldman Sachs. Even that viewpoint is better than the common bearish assumptions of rapid mean reversion. Here is the key chart:

• Nouriel Roubini is "optimistic" on stocks. (via John Sullivan at AdvisorOne). We always admire those who use facts, changing forecasts as indicated. For those who will call this a contrary indicator, you need a reality check. That interpretation guarantees that you will never change your mind.
• The trade deficit improved – a lot! This certainly flips the sign on the preliminary Q412 GDP report, and may represent an increase of as much as 0.7% Contrary opinion from Steven Hansen. Here is a helpful chart from Calculated Risk:

• Home prices are up 8.3% year-over-year. The CoreLogic data is reported by everyone's go-to source on housing, Calculated Risk.

• The earnings beat rate is still strong. Revenues, too. Despite the twist you might have seen from your favorite conspiracy site, Bespoke has the real story, with the expected great charts:

  So far this earnings season, 64% of US companies that have reported earnings have beaten earnings estimates, while 63% of companies have beaten revenue estimates.  As we highlighted last Friday, both of these readings are strong compared to past quarters over the last few years.

The Bad

There was some bad news, but not so much on economic data.  Feel free to add in the comments anything you think I missed!

• Insiders are selling – big time! Mark Hulbert says that the pace is the fastest in several years. Cam Hui emphasizes the warning, pointing out that potential tax selling is no longer an excuse. Guy Ortmann of Scarsdale Equities also hit this theme in his excellent daily commentary. "…(T)he sentiment indicators are flashing very red warning lights as follows. The Rydex Ratio (contrary indicator) is now at a 10 year high of 48.8 showing the leveraged ETF traders as more bullish than at any point in the last decade. We would note that at the market lows in mid-November they were at a bearish extreme not seen since February 2009. Sell low, buy high??
• Gas prices are up. It is the biggest share of pre-tax income in decades, about 4%. (via The Hill's Energy Blog). Sober Look sees a possible effect on consumer sentiment and spending and provides this chart of the front-month futures:

• Factory orders were a little light.
• Productivity is lower, implying slower growth. (Via Scott Grannis). Alternate view from Steven Hansen of GEI.
• Initial jobless claims moved higher. So much for the 300K range. Bespoke has a good chart with helpful notes:

The Ugly

The Wall Street Journal reporters have been urged to do shorter and funnier articles. I know the feeling! Mrs. OldProf, looking up from her book, just asked me about the length and humor quotient of today's piece. I admitted that it was long and laden with lessons about Ben Franklin, compromise, and what really will matter to our investments.

She recommended that I find something to spice it up a bit. The big-time bloggers all write about cars and music and such. Good advice! We all know that on Wall Street if you want a friend you should get a dog. Here is her suggestion for your next dog. It brought a smile to my face.

Recommended Reading

Abnormal Returns points to the Credit Suisse Global Investment Returns Yearbook. Tadas starts with an intriguing chart. The Yearbook explains that one and more. This is worth some time to study.

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. He also provides this helpful chart of the ECRI's public indicator:

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.  The low current rating means that few ETFs are in the penalty box, so we have more confidence in the overall ratings. 

[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 is extremely light on economic data.

The "A List" includes the following:

• Michigan Consumer Sentiment (F). More important than usual because of the recent dip, fuel prices, and the payroll tax increase.
• 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:

• Retail Sales (W). Holiday season is significant. Confirmation of same-store sales?
• JOLTs Report (T). No one seems to do a really good job with this, since they try to infer overall employment. It is more about structure.
• Industrial Production (F). This is an element of GDP, so it will be watched closely.

The State of the Union on Tuesday night will be the big story of the week.

There will be Fed speeches almost every day. These are not really relevant given the Fed guidance, but that will not stop the pundits.

Earnings stories are winding down, but still noteworthy.

Trading Time Frame

Felix has continued a bullish posture. Felix did pretty well last 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.  Felix has been cautious, but still has caught most of the rally, and done so with less risk. Felix has been bullish in 2013, but the ratings have been declining a little.

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.

The current investment climate offers a dearth of choices!

Prof. James Hamilton has a great post explaining your choices: "The question is maybe not what is a good investment right now, but instead what is the least bad investment." He writes further as follows:

But what else are you going to do? Low as the dividend yield is on stocks at the moment (2.04%) , it's still better than what you can get on a 10-year U.S. Treasury bond. Moreover, any inflation in the prices of the goods and services that firms sell, as well as any profit gains associated with a larger market, should boost those dividends over time, whereas inflation would continue to erode what you make on the Treasury. Or you might look at a Treasury Inflation Protected Security, whose coupon will rise with the headline CPI. That's currently yielding a hefty -0.57%. Anybody want to sign up for that 10-year plan?

High-yield bonds are dangerous, partly because of the stampede for yield. (Formerly referred to in my series merely as the Quest for Yield). David Schawel (in an article highlighted for us all by Abnormal Returns), writes as follows:

Greater price risk now exists: The devil is always in the details, and price is an important risk that most corporate bond investors, in my opinion, are overlooking.

Gold is currently on a "sell signal" according to Georg Vrba, whose technical model follows the Coppock indicator.

The last sell signal was at the end of November 2012 and no new buy signal has so far appeared. What is needed now for an early buy signal is a sustained upward move of the gold price to over $1,700 during the next few weeks, something which is certainly not outside the bounds of probability.

Meanwhile, we have continuing "headline risk." Buying stocks in times of fear is easy to say, but so difficult to implement.  The big-shot experts on TV are calling you the dumb money, even when you have been right! (in case you missed it, see this discussion).

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."

There are some alternatives, but the answer is different for each investor. 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).

Final Thought

Is there realistic hope for a budget compromise?

Most of the pundits you see or read have little understanding of history, Congress, or the policy-making process. For them the answers are easy and obvious. Anyone who does not agree is a fool.

I am currently spending my leisure time reading Walter Isaacson's wonderful biography of Ben Franklin. As I read the final chapters on the Constitutional Convention I am struck by two themes related to compromise:

1. The U.S. Constitution required serious compromise of strongly-held principles by all parties. Franklin was not a great orator, but his final speech to the convention is widely acclaimed as stimulating the needed support for this new government.
2. The resulting government implemented checks and balances that would make compromise the order of the day for progress.

If you do not understand this, you will never be able to see how government decisions affect your investments.

Senate Democrats are vague but hopeful in their comments. Obama has earlier stated that the sequestration cuts would not occur. I will be closely watching Tuesday's speech for signs of flexibility and bi-partisanship.

Investment Conclusion

I anticipate plenty of SOTU discussion on Wednesday. The challenge will be to sift through the partisan commentary.

Avoiding sequestration would be bullish for the overall market. My guess – and that is all that anyone can do right now – is that observers see this as a 50-50 proposition or worse.

Specific sectors that would be helped relate primarily to defense stocks, a group that I'll be watching closely. (NOC, LMT, and RTN, are candidates).

[Currently long hedged positions in NOC and RTN for some accounts.]

Weighing the Week Ahead: Market Correction Coming?

Whenever there is a big market move – in either direction – the question arises: Is it too much, too soon? I predicted that this week's focus would be on whether it was time for the individual investor to return to stocks. That was a good forecast ---for about two days!

The media tilt ensued very quickly. Since consumers of financial media are looking for actionable advice, the sources have a tilt toward trading. We all know that markets do not move in a straight line, so any significant move brings out those planning to "sell the rips and buy the dips."

Here are three interesting perspectives:

Correction Ahead

Some of the calls for a correction even emphasize the recent shift in fund flows, reflecting the change in attitude by some individual investors. Here is an example from BofA Merrill Lynch strategist Michael Hartnett, reported by Matthew Boesler of Business Insider.

For Hartnett, this implies a possible correction of 5% over a month or so. The article cites similar forecasts from other Street analysts.

Probable New Highs

Charles Kirk has, as usual, a balanced viewpoint in his weekly chart show. While noting the potential for a correction, Charles expects a test of the old highs first, possibly followed by a completion of the current bullish chart setup. My brief summary is but a shadow of what you get from the weekly chart show. (The Kirk Report requires a small membership charge, and is well worth it).

A Longer View

Taking a longer view, Josh Brown has an excellent post, Ray Dalio Schools You on the Great Rotation Debate. This must-read article explains why the current inflows to stock funds are not merely from bonds and not just from individual investors. Josh has taken the key points from a Dalio interview, helping his readers to see what is really important.

Naturally, I have my own thoughts on this topic and I'll cover those 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:

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

The Good

This was another good week, both for data and for earnings. The most important reports were positive. 

• Year-over-year growth in forward earnings – confirming the trough in Q3 of 2012. Even CNBC got on this theme last week, belatedly following the on-target commentary from Brian Gilmartin. Brian notes that the estimates are still declining a bit, but reflect an increase of nearly 6% over last year. Read the full report for plenty of detail and interpretation that you will not see elsewhere.
• Q4 earnings reports continue to beat on both the top and bottom lines. Bespoke has their typically fine charts, including this one on revenue:

• China is looking better. Or is it? We have been following the dueling PMI indicators for months, with Markit's version usually more pessimistic than the "official" version. Now this has reversed. I am scoring this in favor of Markit, but there is a great analysis by Kate Mackenzie at FT Alphaville and also good commentary at GEI.
• Employment continues to improve, especially when you consider the final revised data. See Phil Izzo's excellent summary of economic opinion. In my monthly preview I explained why you need to look at the final results from state employment data, not just the preliminary estimates. We all know that employment gains trail what is needed for a robust recovery, but there is progress.
• The ISM index notched a significant upside surprise, with solid contributions from the various subcategories. The 53.1 reading is consistent with real GDP growth of 3.4%, according to their research.
• Housing data showed another week of improvement including both construction and Case-Shiller home prices. See Calculated Risk for both themes. The Case-Shiller approach has a three-month average that is not seasonally adjusted. The Calculated Risk chart makes it easier to see the current trend.

The Bad

There was plenty of data, and some of it was negative.

• Initial jobless claims rebounded to 368K after two weeks of dramatic improvement. It is a challenging time for seasonal adjustments.
• Conference Board consumer confidence disappointed at 58.6, down from 66.7 last month. This corresponded to the mid-month decline in the Michigan index. Payroll tax effects?
• The spike in personal income was deceptive according to Dwaine Van Vuuren's analysis. He expects January to decline, reflecting the pulling forward of income because of fiscal cliff fears. Dwaine pays special attention to this indicator since it is part of his NBER recession model (details here).
• Gasoline prices moved higher, continuing the recent trend (via GEI).

• Europe's problems continue. FT.com notes the increase in European business confidence. The Bonddad Blog says that Europe is "Still a Mess" and provides a chart as evidence:

• Employees were surprised by the payroll tax increase. Anecdotal evidence from Tim Duy.
• Q4 GDP had a negative print of -0.1% in the advance estimate. Doug Short and Steven Hansen of Global Economic Intersection call this a "nasty surprise" and provide plenty of charts and data to show some historical perspective. Many felt that the data included a convergence of "one-off" effects and the market shrugged off the news. See (MarketWatch for a summary of points and Econbrowser for Prof. Hamilton's take and more links). Scott Grannis shows why the current economic growth is not enough.

The Ugly

The government threatens our personal rights according to a majority polled by Pew Research. This is a dramatic increase from a decade ago. Most people do not realize how important this is. The U.S. government depends upon confidence and trust, typically most evident among the best educated and most successful citizens. What has happened, and what will be the consequences?

Global Economic Intersection has a good account. Here is one of the charts:

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. Nothing I follow suggests an imminent recession.

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 recently published 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.

New Deal Democrat at the Bonddad Blog has been a bulldog on tracking the ECRI forecast, including the many changing claims.  His latest post refutes the most recent ECRI "telltale charts."  The ECRI seems to have responded, but only to their subscribers.  Eventually we might learn what they said.

The average investor has lost track of this long ago, and that is unfortunate.  The original ECRI claim (and the supporting public data) was 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 is rather light on data, after last week's deluge. The calendar quirks can do this.

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. Seasonal adjustments have made the results difficult to interpret.
• Trade balance (F). Especially after the GDP report we are interested in both exports and imports, as well as the balance. This report is growing in significance.

The "B List" includes the following:

• Factory orders (M). Too much of a backward look to be a top indicator, but still relevant.
• ISM Services (T). Services are bigger than manufacturing, but this series does not have the history of the more famous index.

It is still the heart of earnings season. These reports will be more important than ever in the absence of major economic news.

Since the FOMC meeting is over (with little excitement), we will have another round of speeches from various Fed participants. I am not expecting much, but traders will be alert for any hints of dissent.

Trading Time Frame

Felix has continued a bullish posture, fully reflected in trading accounts. Felix did pretty well last year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Felix got back into the market in a timely fashion.  Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral.  Felix has been cautious, but still has caught most of the rallies, and done so 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."

The year is starting much as I predicted in my 2013 preview for Seeking Alpha.  This article covers key investor catalysts, as well as 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.

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).

Final Thoughts

Is there a looming correction? I have four very different thoughts.

1. People are always trying to predict the next short-term market move. While someone is always right, the allegedly great records are either back-tested or focus on a few highlighted calls. Before falling for this I urge readers to check out my post, The Seduction of Market Timing.
2. The fund flow shift has merely started! Those claiming that the individual investor is buying the market top need to look more carefully at the data. We have had nearly $400 billion in outflows from stock funds during the current bull market. The reverse shift so far is less than $20 billion. It is too soon to call this "dumb money."
3. Felix is still positive. It is true that our Felix model does not try to predict corrections, but he is not far behind when things change. Markets that are theoretically overbought can stay that way for some time. There are a few pundits and managers who have been predicting a correction constantly for several years.
4. The facts have changed. It was only a month ago that many (most?) thought we would go over the fiscal cliff, leading to a recession and a crash in corporate earnings. They also thought that the U.S. might default on debt. These things did not happen, nor did we enter a year-end recession. Isn't that worth six percent or so in market value?

Those who set their 2013 price targets before the year-end news need to take a fresh look at the evidence!

And finally, I am sure that there will be a correction during 2013, since there nearly always is – even during the best years. This is part of my message to every new client. For your long-term investments it is important to "right size" your position. If you are "too big," you will get nervous and bail out when the inevitable and normal correction comes.