Weighing the Week Ahead: Economic Transition from Stimulus?

The long list of government stimulus and assistance programs were all intended to be temporary.  As the programs gradually end, one question is paramount:

Will there be a successful transition from government stimulus to a self-sustaining economic recovery?

Some economists are maintaining solid growth forecasts for the remainder of the year.  They see the current slowdown as the result of follow-on effects from the Japanese earthquake and tsunami and from higher gasoline prices.  If these effects are temporary, the moderate growth should improve.

Economic growth expert Michael Mandel, another of the impressive group of Kauffman Conference participants, notes that the expected transition from government stimulus to business investment is not yet showing up.  Here is one of several key charts.  See the full article for his fine analysis of this problem.

 

I do not yet see a "double dip" recession from the slowing data, but the lower trajectory of growth leaves less room for error.  Check out Econbrowser's analysis of economic forecasts and you will see that mainstream economists embrace this position.  One reason is that the effect of the end of QE II buying has been overstated by many investment analysts.

 

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.

Readers often disagree with my conclusions.  That is fine!  Join in and comment.  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 mostly negative.

The Good

These are all items that are either important right now, or bear watching -- a little bit of good news.

• State tax collections are up 9.1% over last year.  The Rockefeller Institute at SUNY-Albany (HT Calculated Risk for the pointer) monitors 47 early-reporting states.  Revenues are still 3% lower than peak levels, but the story is improving nicely.
• University of Michigan Consumer sentiment improved by 2 points, beating expectations.  The results were probably helped by lower gas prices.  The general level of confidence is still lower than we need for a good recovery. 

The Bad

There was a lot of disappointing economic news. 

• Initial jobless claims of 424,000 -- too high to expect solid job growth.
• Housing data was even worse than expected.  This week's bad housing data were the pending home sales.  As Calculated Risk points out, this suggests weaker sales data in the months ahead. 
• The "minor" reports were very bad.  This included industrial production and the GDP "internals."
• European sovereign debt issues, bailouts, and scandals.  The headlines included the lack of a solution in Greece and more negative credit watches.  The IMF still has not chosen a new head.  These headlines are still getting attention, and the effects have not shown up in the SLFSI data.  Some see this as the biggest market threat, although the linkage to US markets is always a little vague.  I am certainly watching, and you should be, too.

The Very Sad

The unexpected death of CNBC's Mark Haines is a loss felt by everyone in the investment community.  Mark has been a part of my morning for over twenty years.  His interviews reflected his preparation and legal background.  While he had a viewpoint, the interview subject always had a fair chance to make his case.

We will all miss him, and our team extends condolences to his family and CNBC colleagues.

The Indicator Snapshot

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

• The ECRI Weekly Leading Index and the derivative Growth Index
• The St. Louis Fed Stress Index
• The key measures from our "Felix" ETF model.

There will soon be at least one new indicator, and the current choices are under review.

The indicators show continuing modest growth at a slowing pace, with little indication of economic risk.  The market fears, as usual, are greater than one might expect from the data.

Felix is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.  This is our first bearish forecast in a long time.

[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

There are some very important economic reports this week, especially the ISM index and the monthly jobs report.  Payroll employment growth, still much lower than needed, has actually done better than one would expect from the rest of the economic data.  With higher jobless claims and weak consumer confidence, I am not expecting a strong report.  I'll do my regular preview at mid-week.

Case-Shiller home price data will probably also be weak.

Investment Implications

In trading accounts last week we pulled back on the asset allocation to the 40% range, including only utilities (XLU) and consumer staples (XLP).  The index inverse ETFs have small positive ratings, but are currently in the penalty box.

For investors, it is attractive to invest when fears are worse than fundamental conditions.  Having said this, we continue to exercise caution in establishing new positions..  There is no rush and a lot of uncertainty.  We always try to find good entry points.

 

Comments

[scm0330]

Jeff,

UST rates in the 5-7 part of the curve initially rose from pre-QE2 levels, and have more recently backed off, though to levels still higher than at the start of the program. I'd submit that the absolute level of rates was low throughout the period. (Although you didn't ask, risk assets generally rose, as did oil and gold, through the period. And the dollar weakened. And more recently, the domestic economic growth rate has weakened.)

As to what UST rates would have been, this is simply unknowable.

However, I wonder if the mosaic above doesn't describe a liquidity phenomenon: a big buyer whose very activity creates credit reserves, and monetary growth; a weakening currency; dollar-denominated hard assets and paper assets rising in nominal value. If that is a plausible case, then I'm wondering what things look like when the aforementioned buyer backs away.

Looking forward to your thoughts.

[oldprof]

scm -- I'll try to use your comments as part of my agenda, so thanks for amplifying.

To get ready, you might ask yourself the following question:

What impact did QE II have on the Treasury market? What would rates have been in the absence of this $600 B buyer?

Jeff

[oldprof]

Jeff -- If you look carefully you will see that these are not forecasts for the next week, but for the next 30 days. We run our model every day, but report the results publicly just once a week.

If you want to do a test of the forecasts, you need to check the 30-day result starting at the time of the forecast. Looking at what happened the first day of the 30-day period does not tell you very much.

I checked out the results a couple of years ago and it was providing edge. Since then the Felix forecast has caught most of the market rally. It was also bearish for much of the 2008 decline.

I should emphasize that we use Felix mostly to find the best sectors, so the overall market forecast is secondary.

I agree that we should be objective. I invite you to join me in looking at the problem using data -- testing the forecasts over a long time period and using the 30-day result, not just using a couple of weeks before the complete results are even in!

As to the proper time frame for market forecasting, this is a topic I have taken up many times. Your choice of time frame definitely should influence your decisions.

I try to distinguish between the investment and the trading perspectives in every article, and I also say when there is a lot of uncertainty. That means that I have less confidence in the prediction.

In general, I agree with your statement favoring long-term forecasts, but many successful traders look at time frames of minutes or hours.

Meanwhile, I advise you not to bet against Felix!

Jeff

[scm0330]

Jeff,

I'll look forward to your more in-depth reply, but my simple mind isn't quite getting things at the moment...the way I see it, a $600B has walked away from the table and isn't buying fresh UST debt. Doesn't that leave a $600B hole to fill, that will come from someone else's pockets (and that someone can't credit federal reserve balances at a keystroke, meaning it's real money being used to buy the $600B of fresh debt, coming out of money supply).

I get that this $600B is a drop in the ocean when we consider annual trading volumes as the denominator. But is that fair? By that logic, it would seem that our buying MBS in QE1 was similarly a non-event, given the size of the mortgage market. Shouldn't we be using a marginal, and not an average, analysis? And, I wonder, is/was there a market distortion when the primaries \knew\ there'd be a size buyer for the fresh paper...taken to a nefarious end, it's more back-door recapitalizing of the dealers, who were selling the USTs back to the Fed at slightly richer prices than they bought the issue. No?

[Jeff]

When are you going to discontinue your weekly market forecast charade? Get real -- Nobody can forecast what the market will do for the next week. Try 6-month minimum forecasts and you might be more credible.
2 weeks ago -- you said bullish. market result was neutral.
last week -- you said neutral. market result was bullish.
this week -- you say bearish. market up over 1% the first day of the week.
You need to add several more factors to your model to have a more comprehensive, reliable forecasting methodology.

Please don't get defensive; try to look at this question objectively -- Weekly forecasts?????

[oldprof]

scm -- Sorry to be slow in responding. When I am traveling and have a lot of meetings I always think I will do more than I really can. Your question is excellent, and I decided to make it the basis for an article which I did not finish last week.

I'll give a summary here, but it really requires more explanation. The actual Fed buying is less than 1% of the daily trade, so ending fresh buying will not have much effect. The Fed balance sheet will remain at the expanded level, so there is plenty of room for more bank lending. This set of conditions is not a tightening at all, but a continuation of monetary stimulation. The limiting factor is bank willingness to lend.

The actual economic effects are quite modest, but the perceived effects are very large. I am sure there will be some additional "explanations" about why the world did not end, but eventually it will all be clear.

Good question -- more later.

Jeff

[scm0330]

Hey Jeff,

Still curious as to your thinking on the cessation of QE2. I'll tread carefully, because I don't want to put words in your mouth, but I believe you've opined that QE2 was mostly a non-event...maybe a mild booster shot to a healing economy.

But now, I see many current and leading indicators turning down, some sharply, and at the same time a $600B buyer is leaving the market. Three related questions:

1) Does the end of QE2 mean tighter liquidity in financial markets?

2) If yes, does that much matter for asset prices, or for transmission effects to the real economy?

3) Where among the indicators you follow would this illiquidity start to present itself (St. Louis index)?

Of course, the recent UST market has certainly not lacked for buyers. But then I ask myself whether that's a strong selling point for buying/owning risk assets! Curious as to your perspective on any/all of the above. Thanks.

[oldprof]

jadoube -- Heh heh -- fair enough.

You cannot watch and work. I have mentioned our method for CNBC viewing a few times, but perhaps not recently. Like most offices, we have it on "mute." We also use TIVO. When there is something relevant to one of our positions, we can scroll back to watch more carefully.

Some segments deserve more attention, but you learn to choose.

Meanwhile, we have moved far from the days when I saw CNBC on in restaurants, bars, and even parking garages!

Jeff

[jadoube]

The Mark Haines comment means you have listened to CNBC every morning for the past twenty years. That virtually disqualifies you from being a successful investor.