Developments last week helped to resolve some key market worries. It should be cause for celebration.
Change in Egypt came with less blood and better future prospects than most expected. This is good and important news.
Earnings season continues to show strength - -not just in the bottom line but also in revenues and profit margins. Since expected earnings are the most important consideration in evaluating stocks, we need to watch this news very closely. Zacks Investment Research does a great job of monitoring earnings trends. Dirk Van Dijk's article, A Trillion Dollars in Earnings, is chock full of data you need to know. He provides some cautionary comments, but his look ahead deserves attention:
The early expectation is for 2012 to have total net income passing the $1 Trillion mark to $1.0113 Trillion. That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $106.79. That is up from $57.71 for 2009, $82.93 for 2010, and $95.20 for 2011. In an environment where the 10-year T-note is yielding 3.63%, a P/E of 15.8x based on 2010 and 13.7x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is 12.2x.
With almost two 2011 estimates being raised for each one being cut (revisions ratio of 1.88), one has to feel confident that the current expectations for 2011 will be hit, and more likely exceeded. Analysts are raising their 2012 projections at almost the same rate, with a revisions ratio of 1.83. While a lot can happen between now and the time the 2012 earnings are all in, upward estimate momentum means that the current 2012 earnings are more likely to be exceeded than for them to fall short.
The earnings story has been strong. I'll return to some comments on how to play this, but first let's do our regular review of the week's data.
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.
For a comprehensive look, check out my new colleague Steve Hansen's weekly data review. (I am delighted to be added as a contributor at Global Economic Intersection. I respect the people, love the format, and appreciate the collegial willingness to mix it up when contributors disagree).
In most of my articles I build a careful case for each point. My purpose here is different. 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 some will disagree. That is what makes a market!
Last Week's Data
The news last week was good, but there was not much market reaction.
The Good
Most major economic indicators remain in positivce territory. Last week I noted that the economic rally now has a self-sustaining character.
- Economic growth is still improving. The ECRI Weekly Leading Index hit a 39-week high and the growth index reached a 37-week peak. This is a signal of solid growth for as far ahead as they are willing to forecast.
- Risk as measured by the St. Louis Fed Stress Index, edged slightly lower, remaining at a very low level. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to .026, even lower than the .046 from last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now.
- Initial Jobless Claims. This is a noisy series, so I focus on the four-week moving average. Since I regularly cite the over 400K weekly numbers as "bad" it only seems fair to note the dramatic improvement last week to 383K. We shall see if this continues.
- Bank Loan Requirements. I have been pondering when to include this news (a decision on 1/25/11) in our weekly report. FASB has abandoned a plan that would have extended mark-to-market accounting to a wide range of loans in the portfolio. Instead, banks can now amortize performing loans while making a reasonable allowance for loan losses. Putting aside what you think of the merits of this decision, it certainly improves the chances for loans to new and small businesses. That makes it market friendly, which is my working definition for the "good" and the "bad."
The Bad
There is not much in the way of fresh bad news. There is a continuing problem on several fronts, a widely known "wall of worry" that is reflected in current market prices. Beyond the change in interest rates, I did not see anything that became notably worse during the last week, but feel free to offer comments.
- Interest rates higher. Mortgage rates moved above 5% for the first time in more than a year. This is typical of rates all along the yield curve.
- Consumer Confidence. The Michigan Consumer Sentiment Index missed expectations and the ratings languish at levels normally associated with recessions. This highlights the fact that despite the recovery in many economic statistics and the strength in corporate earnings, there is a continuing gap between economic performance and the level needed for full employment. Doug Short places the current ratings in perspective with the following chart:
Read the entire article to see similar charts and data for the Conference Board reports and for small business confidence.
The Misguided
To understand the current market, one must start with the popular perception -- a viewpoint that has been more negative than warranted by actual data for several years. The average person has an inadequate grasp of the facts. This limits understanding of issues. David Altig of Macroblog, one of our featured sources, tackles "...the tricky nature of the semantics of any discussion about 'inflation.'" In the most recent Pew News IQ poll, the worst score (14% correct) was the multiple choice question about the reported rate of inflation. You might also enjoy taking the quiz yourself. There are only 12 questions, and I expect the astute readership of "A Dash" to get near-perfect scores.
Why is public understanding of basic facts so low? It is a matter of what people read. Here are two stories from a single day last week, dramatically highlighted by the Grumpy Editor (HT Talking Biz News -- a featured source).
Editors, for yesterday's newspapers, had to decide which was of more interest to readers: a story on troubled actress Lindsay Lohan going to court or the capture by pirates of a U.S.-bound supertanker that provides one fifth of daily U.S. crude imports --- and somehow vanished, notes Grumpy Editor.
They decided on major print space for Lohan and a few lines, or none, on the Greek-flagged Irene SL, the oil-laden ship captured --- in one of the biggest hijackings of all time --- in the Arabian Sea.
We have a terrible downward spiral both for print media and online sources. Those of us writing real substance feel like an obscure cable channel. In the old days -- a few years ago -- editors could decide what stories were important based upon the merits. If you were an editor, which of the stories would you feature?
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned cautious. Two weeks ago we said it was a close call, and switched to neutral. Last week it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll. We remained bullish this week. The poll is now conducted on Thursday night, so it does not reflect Friday trading or the bullish news from Egypt. Here is what we see:
- 68% of our 56 ETF's have a positive rating, up from 61% last week.
- 73% of our 56 sectors are in our "penalty box," equal to 73% last week, and an indication of significant short-term risk.
- Our universe has a median strength of +18, up significantly from +7 last week.
The overall picture is slightly bullish. We remained fully invested in trading accounts since there are several strong sectors, but we are watching the indicators quite carefully. This has been a very close call for several weeks.
[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.]
The Week Ahead
There are a number of interesting data reports this week. The ones that I watch include retail sales, building permits (the best forward housing indicator), CPI, and initial claims. They Philly Fed index could be important if it differs significantly from expectations, but it is not on my "A" list.
Interest rates bear watching.
The biggest buzz will be on the Federal budget and the deficit projections. President Obama has not gone far enough on the deficit front, and has achieved his improvements in a way that most Republicans will not like. We are about to see a month or so of negotiating with the debt limit and a possible government shut down as a threat. Stay tuned!
Investment Implications
For long-term investors I have been looking for entry points and have been frustrated by the lack of any significant correction. The market reaction suggests that I have some company.
Conditions have improved significantly over the last few weeks, dramatically reducing some market worries. The data changed our official investment posture in the last few weeks.
In distinct contrast, most of our dependable sources of market worries have seamlessly shifted from one theme to another.
Listen up! There is always something to worry about. Using actual data would be a refreshing change for many investors. The next time you read an article about "headwinds," look to see if there is any supporting data.
I have a shopping list of stocks with great earnings forecasts and a price target for my buys. If you want to find your own stocks, I recommend Chuck Carnevale as a great place to start. You need to be willing to do some work and learn about earnings. Start here.
another great article Jeff. well done and thank!
Posted by: Paul in KC | February 14, 2011 at 04:57 PM
Inflation is indeed tough to understand. "When prices go up it's inflation, but when they go down it's smart shopping."
I think there's just too much variability in what and where things are purchased, especially food prices that are already volatile, to conclude as many do that "prices are zooming up" and that inflation rates must be understated.
Posted by: Proteus | February 14, 2011 at 08:50 AM