Weighing the Week Ahead: Keeping Turmoil in Perspective

Will the next month bring an important market inflection point?

Many seem to think so, raising a good question:  When many market participants expect something, does that make it more or less likely to happen?

Nearly everyone is anticipating a market correction.  Even those with a bullish viewpoint have one foot out the door.

Barry Ritholtz is willing to see opportunity here.  In a great interview with Forbes, entitled Stop Criticizing Bernanke, Start Finding Investment Opportunities, Barry emphasizes the need to put aside your politics and policy opinions and pay attention to specific stocks.

We’re now about 86% long and have been for some time.

We have been finding names on a bottom up basis. I think many people had expectations that with the coming end of QE2 the world was coming to an end and that the market was coming to an end. We just don’t see that happening anytime soon. Right now, I think we’re at the phase of the market where a lot of people are specifically looking for a correction, and we just don’t see that as imminent. While there’s very likely a 25% correction, somewhere out in the future, we’re just not there.

I agree.  The skeptics have been looking for a 25% correction while the market has rallied 75%.  Corrections are part of investing and they are difficult to time.

My own approach is to focus on a collection of indicators that capture the risk/reward tradeoff. The biggest current market questions come from four sources:

1. The reduced rate of economic growth.  This is popularly described as a slowdown and in one case, a "cruel summer."  Since few seem able to distinguish between a reduction in the rate of growth  and a growing economy, there is an opportunity for those who can.  The ECRI is not forecasting a recession, but you should watch the video for yourself. 
2. The end of QE II.  Regular readers know that I think this will be a non-event in terms of the fundamentals.  We still must deal with perceptions.  In the first of several planned articles on this topic I explained why the recent stock market rally makes complete sense to those of us focused on market fundamentals.
3. The long-running, widely-publicized, and so far inaccurate prediction about declining profit margins.
4. Various theories described in terms of cockroaches, dominoes, or headwinds.

The challenge for investors is to put these valid questions into a sensible perspective.  If you are unable to recognize excessive worries, you will never make a good investment.  In an interview last week with Tadas Viskanta of Abnormal Returns, I tried to pull together several of these themes.  Even regular readers might enjoy watching the screencast, if only to put a face and a voice together with the text.

Despite this constructive background, I am more cautious this week, as I explain in the conclusion.  But first, I will do the regularly weekly data review -- with a few changes.

In response to comments and suggestions (Thanks to all!) I am introducing some new ideas in the format for the WTWA article.  My objective is to display the indicator data in a way that is easy to see and also provides additional historical perspective.  Today's piece is the first step.  Over the course of the next few weeks I will have a separate discussion of each indicator, as well as a new addition or two. 

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.

I always do the work to think through the issues, my preparation for the week ahead.  Writing the article and 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.

• Gas prices fell by about ten cents.  The decline still does not reflect the fall in oil prices and the reduced risk for Louisiana refineries.  Calculated Risk does a good job discussing the importance of high gas prices on consumer confidence and the economy.
  
• Mortgage rates hit another new low.  The Bonddad Blog also points out the increase in refinancing activity, as part of the regular weekly data review.
• Bank lending to small and medium sized businesses has improved (via Scott Grannis).
• Initial jobless claims dropped sharply, 70,000 lower than two weeks ago, but still holding in the unacceptable +400K range. 

The Bad

There was a lot of disappointing economic news. 

• Housing data was even worse than expected.  Whether you look to overall sales, housing starts or (my favorite) building permits, the data were even worse than expected.  Check out Calculated Risk for full analysis and the expected fine charts. 
• The "minor" reports were very bad.  In last week's preview I noted that I did not see much significance in the regional Fed reports or the LEI unless they were significantly outside the normal range.  They were all bad -- part of the general pattern.
• European sovereign debt issues, bailouts, and scandals.  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 Amazing

The LinkedIn IPO was a big story last week.  The first-day gains have held up so far, but we still do not have options trading or short selling.  Everyone had an opinion (check Abnormal Returns for the ultimate LinkedIn linkfest), but the opinions ranged widely.  Some see the event as showing investor appetite for the newest technology, some thought it was the sign of a new bubble, and one observer even seemed to conclude that the overpricing was the fault of Ben Bernanke!

While I share the astonishment of those questioning the current price, I am not surprised.  Investors are continually warned about "normal" stocks, told that government data is false, informed that analysts are biased and error prone, and confronted with a wide range of Apocalypse alternatives, only one of which was removed last week.

Is it any surprise that people turn to investments that defy any modeling or analysis?

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

 

 

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.

[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 is not much in the way of important economic data next week.  We get the government version of home prices and personal income and spending at the end of the week.  Earnings news is winding down.  Jobless claims will still be interesting, mostly because the series has been so volatile.

I do not see a clear focus in the expected announcements.  I have been fairly accurate at guessing the big stories for the upcoming week, but it is important to know when you just need to be flexible and to keep perspective.

Investment Implications

In trading accounts last week we pulled back on the asset allocation to the 60-80% range, emphasizing some sectors that are defensive -- utilities and consumer non-durables.

For new accounts we have moved very cautiously on new positions.  There is no rush and a lot of uncertainty.  We always try to find good entry points.

In another six weeks we will have gotten past the official QE II end, and possibly have better news on gas prices.

Comments

[scm0330]

Hi Jeff,

I know you've stated that you believe the end of QE2 will be a non-event. I wonder about the program's end and its effects on liquidity, though...after all, a $600B (run-rate) buyer will be exiting the market. Isn't that, at the margin, a negative for liquidity, and money supply? You had earler stated (in the your recent "Debunking the QEII Rally" article) that the program's liquidy effects on money supply were barely enough to pace GDP growth. I mean, we've got the same deficit hole to fill in FY2012 as we did in FY2011. Won't that money need to come from the globe's existing capital, and won't that have (in theory) some knock-on effects, such as in rates, the dollar, commodities? Or does $600B not flick the needle anymore? Thanks in advance.

[Proteus]

Jeff, love the new format for your indicators, great way of presenting the data. Very easy to follow.

For other indicators, here are a few I like:
The yield curve and the TED spread. (Already in the St Louis index.)
The ADS business conditions index.
The Barron's Confidence Index.
The Conference Board coincident to lagging ratio.

BTW, is the 30 day forecast deterministic, or is it based on your interpretation of the indicators listed?