Weighing the Week Ahead: Back to Work!

The investing community goes back to work on Tuesday for a short week that could see plenty of action.

Everyone is doing a review of 2011, so I tried to do something really different -- The Year that Wasn't!  Please take a look at what might have happened (but didn't) and offer your own take.  I think the theme is worth consideration, so I might do it again if there is interest.

I will have more traditional "year ahead" pieces next week, including some specific ideas for the coming year.

Today's focus is shorter -- the week ahead.  The key question is whether America is also going back to work.  This week will be all about jobs, culminating with the monthly employment situation report on Friday.

Felix remains bullish for the near-term.  While I was skeptical last week, I am more inclined to agree this week.  I'll explain further in the conclusion, but first, a review of a week that was pretty light on real news.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review.  My mission is different. I single out what will be most important in the coming week.  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.

Unlike my other articles at "A Dash" I am not trying to develop a focused, logical argument with supporting data on a single theme.  I am sharing conclusions.  Sometimes these are topics that I have already written about, and others are on my agenda.  I am trying to put 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

There was little on the data front last week, so the temptation was to draw inferences that were not really there.

I'll just stick to the facts:)  I discuss important data releases, ETF updates, and trading ideas in real time on my new investment diary, but there was not much meat last week from the economic data.

The Good

The Chicago purchasing managers report at 62.5 handily beat expectations.  That is thought to be a good indicator for the widely-followed ISM report.

Consumer confidence was better than expected.  This is important, as is clear from my conclusion.  The improvement must be kept in perspective.  Doug Short's fine chart tells the story -- better, but not good enough.

The Notable

There was nothing really bad or ugly, but several events worth noting.

• Forward earnings are still lagging.  This is a story covered in excellent fashion by my WSAS colleague Brian Gilmartin.  For many years he has carefully tracked the data and monitored the trends.  Earnings estimates have stalled, but are not in a decline.  It is something to watch very carefully.
• The Italians were selling bonds all week, and we are all watching the 10-year yield.  The early auctions for short-term paper went well.  The longer-term bonds had a mediocre reception.  We are still waiting for the ECB.
• The Obama approval ratings moved up 4 points.  Most will react to this based upon whether or not they favor Obama.  This is superficial.  From a market perspective, the election is in the distant future.  What I like about this is the warning shot to those who refuse to compromise.  It is pretty obvious that gridlock is not market friendly.  Those of us who want to have successful investments should be paying attention.  We can hope that our legislators are doing the same.
• Initial jobless claims moved a little higher, but within the noise level.
• Housing data showed some improvement, but there is so much noise that inferences are difficult.

To summarize, there was little in the way of fresh data last week, but we are at full attention for next week.

The Silver Bullet

A few weeks ago I initiated what I am calling the "Silver Bullet" award.  The basic concept is the willingness to do a careful and thoughtful analysis in difficult circumstances.

Often this means direct engagement, which is difficult to do effectively in the blogosphere.  It also means the willingness to take the unpopular side of the issue.

When you embark on such a story, you are like the Lone Ranger.  In the spirit of encouraging this type of work I hope to mention a "silver bullet" story each week.  I invite readers to send suggestions.  I expect that this will only be an occasional topic.

This week I want to recognize Joe Weisenthal and congratulate him as Talking Biz News’ Business Journalist of the Year for 2011.  Read their entire citation and you will learn what many of us knew about Joe from his early blogger days as "The Stalwart."

He had so many important stories this year, that picking a single one is a challenge.  Undaunted, here is my suggestion, which I actually tweeted about a few days before his selection.  The big policy and market question of the year is about government debt.

Many conveniently cite a book that they have not read, covering data that they have not reviewed, employing methodology that they do not understand, and reaching a conclusion that is not shared by many peers.  This happens because the conclusions support a viewpoint that they already hold -- quite fervently.  As a result, people are willing to bet real money.

Joe is willing to tweak us all on this subject, so I especially liked his article,  Meet the Two Most Dangerous Economists in the World Right Now.

It is merely an example of something that he does all of the time.

The Indicator Snapshot

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

• An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.  Barring a market surprise, I expect to start covering this next week.
• The St. Louis Financial Stress Index.
• The key measures from our "Felix" ETF model.

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.

 

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.  We voted "Bullish" this week.

[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 is a big week for data -- mostly about jobs.

I am interested in the ISM report on Tuesday because it correlates with job creation, and it is from the same time frame as the payroll survey.  Thursday's ADP report seeks the same answers with a different measurement approach.  We also get initial jobless claims on Thursday, which many will incorrectly view as related to the Friday report.

I do not expect much in the way of fresh news from the FOMC minutes on Tuesday, or the other lesser reports.

So --  Tuesday ISM, Thursday ADP and initial claims, and Friday -- the big day.

Tuesday also has the Iowa caucuses -- the first real voting in the 2012 election.  It also features the Sugar Bowl where the resurgent University of Michigan Wolverines take on the Virginia Tech Hokies.  Tough choice!!  I might manage a tweet or two on the caucus, but what is the rush?

When the choice is Hoke or the Hokies, it is easy for me:)

The WSJ has a nice calendar of upcoming events in Europe -- not too much this week.

Trading Time Frame

Our trading accounts were fully invested last week, as indicated from our ratings.   Felix has actually done a little better than the weekly update shows, since the first "bullish" week -- a loser -- had no trading positions since everything was in the PB.  The entry for this cycle has been very good.

This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  In early October we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our "trigger range," but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an "all clear" signal, but I expect the SLFSI to decline next week.

A reader recently suggested that this method reduced position size at a market bottom in October.  This really misses the point.  When the volatility gets too large, you step back a bit.  Those who do not wind up bailing out on the entire position.  Even if stocks have a big rally from that point, it is better to enjoy it with 70% than to bail out completely, as many did, because the size was too great.  Meanwhile, we are on the verge of increasing size.

This is not about market timing.  It is about risk management.

Our Dynamic Asset Allocation model maintains a very conservative posture, featuring bonds and other defensive holdings.  This method reduces overall volatility, so we expect it to be a little slow at the bottom.

To summarize, we have a very conservative approach in most of our programs, recognizing the uncertainty and volatility.  For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in our Enhanced Yield program.  We have high volatility, and that is a source of opportunity.

Take what the market is giving you.

[Interested readers can get information which you can use for your own investing and/or consider us for some help -- our approach to limiting risk, coaxing out more yield, and exploiting the current opportunities.  This includes a description of how to do a  year-end tuneup.  Write to main at newarc dot com -- no charge, no obligation, and respect for your email privacy.]

Conclusion

Each week I try to find a helpful perspective that is worth consideration.  Zach Karabell has a thoughtful article where he acknowledges all of the main market worries, and then notes the result.

His conclusion is worthy of attention:

We are not in desperate economic times. But we believe that we are, and that is as paralyzing today as it was when Franklin Roosevelt famously intoned on his inauguration that fear itself is the biggest obstacle. In 2012, the American economy will do better than muddle and less than soar. Let’s hope for the new year that Americans can adjust to that reality without succumbing to despair.

This matches my own concept of cautious optimism.

Comments

[Proteus]

Angel: Thanks for the link to the ECB paper. But now I have to go and read/understand it :)

Jeff, hoping 2012 is indeed a prosperous New Year! Your efforts (and I am sure they represent a considerable investment of time) are truly appreciated.

[Angel Martin]

Thanks Jeff. Happy new year to you and best wishes for you and your clients in 2012.

You have really helped my thinking this year, especially about sentiment wrt europe.

On my OTM euro puts, and on currency crashes generally: when they happen, these things always seem to drag on for years and then end with a surprise collapse.

To me, that argues for an OTM options strategy, and being patient and willing to endure a slow bleed.

In the case of a sudden crash to 50 on FXE, current euro options allow for something like 2300 months of time decay so i feel like the strategy has potential... i just hope it doesn't take that long :)

I'm also starting to look at the yen, pound, dollar and the sovereign markets in those countries - all have bad fundamentals as well (esp Japan) and less current negative sentiment than the euro

[oldprof]

Angel -- Thanks for the pointer. I'll take a look.

I very much appreciate your comments and constructive engagement over the last year. I am sure that many others have also benefited -- both from your comments and because you nudge me to another level of response.

Best wishes in the new year. I wish that your options were not so far out of the money so that our interests were more closely aligned.

Putting this aside, I am confident that you will continue to succeed in your investments:)

Jeff

[Angel Martin]

Jeff, I have been looking at alternatives to the St Louis Index.

One I stumbled on has been looked at by the ECB
http://www.ecb.int/pub/pdf/scpwps/ecbwp1327.pdf

It's a really complicated paper, and i understand very little of it (state - space methods?) but one thing they have done is to create a forward looking indicator of financial distress- as opposed to coincident (or near coincident) indicators like the St Louis Index

Also, the pattern post 2009 is quite different from the St Louis Index, with ECB indicator at the end of 2010 at above 2008 levels for europe. (see fig 8)

Jeff, i'd be interested if you have looked at this paper, and your reaction.