Weighing the Week Ahead: Focus on the Economy

For several weeks markets have focused on Europe, with headlines pounding out the message of risk.  There may not be anything really new  to say on that subject, but that will not stop anyone!

I expect continuing actions by European governments, both individually and collectively.  The punditry will criticize each action for being premature (and too slow), not sufficiently transparent (and lacking surprise), revealing weakness by taking an aggressive stance (and failing to deal as comprehensively as did the US).

Put another way, the pundits will all agree that politicians of all sorts are stupid. They will disagree about how and why.  This will be a convenient explanation if markets move lower.

Meanwhile, there is a busy economic calendar, and it should get some attention.

Background on "Weighing the Week Ahead"

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important in the coming week.  If I am correct, my theme for the week is what  we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

Last Week's Data

The actual data from last week generally beat expectations .  If you had just been reading the news flow from the US, you would never have predicted the wild swings and negative bias.  Let us take a closer look.

The Good

The economic news was good enough for many to reaffirm a "V" recovery. 

• There is no sign of inflation, no matter how you measure it.  The Fed looks to be on hold for many months, with a tilt toward helping the economy.
• The FOMC minutes confirm the general bias of Fed policy.
• Rail traffic is strong.  This is a solid, measurable economic indicator at the highest level since 2008.
• Mortgage rates declined again.  (so much for worries about the end of Fed buying).

This is continuing solid news.

The Bad

I am pretty fussy about economic news related to jobs and housing, and I did not like what I saw.

• I closely watch building permits as the best leading indicator of new construction.  Construction is up (reflecting the tax credit, which has now expired) but building permits were down 11.5%.
• The BLS report on Business Dynamics showed job losses for the quarter ending in Sept., 2009, were about 300K worse than expected.  You will not see this news anywhere else.  Even though this is an "old" report, people should watch it as a way of verifying the accuracy of the "official" BLS payroll employment report projections.  Basically, this is an early read on eventual "benchmark" revisions.  There was plenty of job creation, including a million jobs from new establishments, but still not as much as estimated.  More detail is beyond the scope of this weekly summary, but those interested can get the essentials of the argument in my analysis of the November report (different time, same issue).
• The uptick in initial claims was also a negative for jobs.  We really need to see progress on reduced layoffs and more job creation.  Both seem to have stalled.
• The S&P 500 broke the 200-day moving average.  Many people view this as the most important technical indicator, keeping them on the right side of major trends.  This is being quoted as 1102 or so, and is something to watch.
• The ECRI indicators are in the growth area, but weaker than in past weeks.  Their interpretation?  "With WLI growth sinking further to a 43-week low, U.S. economic growth is set to start easing in fairly short order."  This seems to be an unusually strong emphasis on a "second derivative" interpretation of a strong reading, but it is their index.  I look at their numbers, but also at their own interpretation.

The Ugly

The high volatility in trading is frightening to nearly all investors.  Thursday was especially bad.  The extremely late rally on options expiration day makes the week's pricing look a bit better, but most observers will need much more convincing.

Market behavior is making the worst of every piece of news, a trend that traders must accept.

The Irrelevant

There was a lot of meaningless noise.

• LEI.  I do not find the "Leading Economic Indicators" to be very helpful so the downtick is irrelevant for me.  These indicators are not very good at leading.
• Financial Reform.  There was a lot of silly commentary on this subject.  Some attributed selling to this cause, just because the timing fit.  Consider these points -
• • No one really knows what will happen.  We still need to have a conference committee to reconcile the House and Senate versions.
  • Barney Frank has tipped off the House position.  I realize that most market observers do not like Chairman Frank and his positions.  Once again, I emphasize that this is irrelevant to our task of predicting outcomes.  His approach is likely to aid financial firms in necessary hedging, as well as other things.
  • The Senate version of the bill is actually better than was generally expected.  See Barron's on this.
    

The Week Ahead

It is a big week for market data, including multiple readings on housing and consumer confidence.  There will be data on durable goods, personal income and spending, and the Chicago purchasing managers report.

I am particularly interested in home price data, although this is subject to massive spinning, mostly negative.

I also closely watch the Michigan sentiment indicator and initial claims, which I see as good indicators of employment.  The Chicago Purchasing managers are often a good read on the ISM index.

I do not expect the European debate to reach an instant conclusion, but the upcoming news is difficult to predict.  This will take years to play out.  Most observers are (unwisely) trying to make definitive predictions of an outcome where the situation is evolving and fluid.

Our Trading Forecast

Our own indicators turned neutral last week and remain so this week.  That was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

• Only 33% ( 31% last week) of our ETF's have positive ratings.  This is moderately weak.
• The median strength is only -5 (the same as last week). This is a slight negative.
• 100%  (up from 98%) of the sectors are in the "penalty box," showing an extremely high level of uncertainty and risk.
• Our Index Package now has a very small negative rating.

[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 email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

For short-term accounts we were short for part of the week, but covered shorts on Thursday.  We currently have no positions.

Investment Implications

For short-term trading, our three-week time horizon, the models indicate that the uncertainty is just too great.  We have no positions.  This position is a matter of daily review.

For long-term accounts, there are many attractive stocks.  This is especially true in technology where the upgrade story is intact, and the stocks declined in the general panic.

I expect another exciting week, although volatility seems to be at a peak.  For some accounts, writing calls against new or existing stock positions could make sense.  Investors should beware of straight call purchases when volatility is so high.  It is possible for the stock to move higher while the option does not fully participate.  If you do not understand this, you should not be trading options.

Comments

[jb]

Thanks for the link! Even though some of it will change and, I'm not sure how the Senate bill can blanket ban banks from trading derivatives (first point), but appreciate your points.

[oldprof]

Curtis -- Briefing.com has a very nice calendar of events. Calculated Risk covers every release and also does a weekly review and forecast. I always read both.

There is so much information. I try to provide a focus.

Jeff

[Curtis]

"There are many good services that do a complete list of every event for the upcoming week, so that is not my mission"

Can you give an example of some of these services? I find it difficult to keep track of this stuff.

[oldprof]

jb -- I sympathize with your general observation about the complexity of current legislation versus the old days. You have encouraged me to write a piece about this.

Meanwhile, this is not just a problem of legislation. It is true of any ordinary business contract, offering document, or agreement. Last summer I saw the Gershwin letter authorizing a musical version of Porgy and Bess. It was a couple of paragraphs.

So your point is correct, but the focus on Congress is less accurate.

Meanwhile, the way it works is that many people read and summarize bills and point you to what you need to know.

In answer to your (excellent) question, you can find out what you need to know in this New York Times summary:

http://www.nytimes.com/interactive/2010/05/20/business/20100520-regulation-graphic.html

Thanks again.

Jeff

[jb]

Isn't it annoying and unacceptable that no one knows what is in the financial reform bill? What has the American legislation process come to?

Somebody told me that Glass Steagall was 20 pages and the current bills are 1000 pages+. What is the probability that a huge bill like that will lead to something good?

Perhaps, not much to do with investing per se but it is very disappointing nonetheless. :(