A Dash of Insight: Housing Issues

Housing Issues

October 13, 2012

Weighing the Week Ahead: Will Q3 Earnings Disappoint?

Earnings season follows a familiar, four-step pattern.

Preliminary -- Analyst estimates are too optimistic, perhaps because they "go native."
Confession -- Adjustment and warnings as companies "pre-announce," usually when the report will be a disappointment.
Announcement -- Actual results with explanations and outlook for the future. There is an initial market reaction to the news.
Interpretation and Spin -- The company does a conference call where analysts either congratulate management or ask probing questions. The stock usually keeps trading during the conference call, and often provides a real-time interpretation of the management discussion.

It is often not easy to interpret. The conventional wisdom is that analysts are too bullish on earnings estimates and also set the bar too low for the actual report. Most seem not to notice that these are contradictory positions.

Rather than starting from scratch on this subject, I recommend that readers take another look at something I wrote more than two years ago. I explained one of our regular themes at "A Dash." Most of the punditry uses words rather than data. The key point is that the earnings story is complicated, which provides many opportunities for spinning.

"Instead, there is a long laundry list of tests:

Earnings -- comps from last year.

Earnings -- meeting expectations.

Earnings -- meeting the "whisper number."

Revenues -- should meet all of the above. The market is very skeptical of earnings from cost-cutting, even though that shows smart management and can easily be reversed. It is a clear-cut bias.

Gross margins falling -- another thing that can be wrong. Even though it might be correct to compete by cutting margins, the pundits will pounce.

Gross margins rising -- evidence of unsustainable earnings on a long-term basis.

Foreign sales -- another no-win area for management. If you suggest that sales were lower, then pundits will infer Europe weakness. If you try to cite currency changes, you get the opposite spin.

Ignore current earnings. Look backward.

Ignore forward earnings. Look backward.

Ignore strong earnings. Look at multiple year growth estimates.

Ignore long-term growth estimates. Those are too bullish.

The added complexity of the earnings story is not helpful to the investor. For consideration by investors who want to look more deeply into this process, I now posit "The Miller Rule."

The more variables, the more spin potential."

Even those who are accurate in forecasting actual earnings may be losers in the short run based upon this list. I'll offer my own take in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog. There is a nice combination of data, speeches, and earnings reports.

In contrast, I highlight a smaller group of events. My theme is an expert guess about 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.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting 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

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The news last week was mostly positive, including these highlights.

The dollar death cross has triggered! For more than a year the dollar has been inversely correlated with stock prices, so this technical indicator is bearish for the dollar and bullish for stocks. See Min Zing in the WSJ for a full account.
Romney pulls even among likely voters according to the Pew Research Center, among others. (Please note the above definition of good=market-friendly. We are not cheering for either candidate. We are analyzing the implications for investments. Right or wrong, the market likes Romney). The effect did not last for even a day, however, perhaps because of some tortured logic about Romney firing Bernanke, whose term ends in January, 2014. Sites analyzing the Electoral College result still show Obama in the lead.

Initial jobless claims dropped dramatically. This sparked more silliness about manipulation of the data. The seasonal adjustments can be tricky at this time of year, which is why we emphasize the four-week moving average. Hats off to Invictus and Barry Ritholtz (see here as well) for helping everyone keep focus on this issue. Here is a helpful chart from Calculated Risk:

Michigan consumer sentiment spiked almost to pre-recession levels. This report deserves more respect. It is an excellent concurrent indicator, but reflecting several factors. In the last year or so the spike in gas prices and the political shenanigans have polluted the results. Normally this is a good indication of employment and consumption. For it to increase at a time when gas prices are elevated and the political silly season is in full swing is very positive for employment. Here is Doug Short's excellent chart, my favorite for this series:

We are almost back to normal levels.

The Bad

The actual data last week was pretty good, but the stock result was bad. This happens, and it can be meaningful. Let us take a closer look.

The world economy is weakening with the threat of a double-dip recession according to new reports from the IMF and Brookings. (via the FT).

Insider selling sends a warning (via Mark Hulbert). I am a big fan of Mark Hulbert, but I am a little uncomfortable with this article. There are always reasons for insiders to sell, since the stock and options are part of a compensation package. (I am the chair of the comp committee for a small public company). It is also natural that selling is higher when the stock price is higher. Insider buying is a much better indicator than selling. But we should watch all indicators, so I advance this for discussion.
The Fed Beige Book suggests only modest growth. Steven Hansen at GEI reports. His research provides an interesting compendium of Fed comments before the last two recessions, which have an eerily similar quality.
Gasoline prices threaten the consumer. The Bonddad Blog tracks this and many other high-frequency indicators (some of which are positive). You really need to follow the complete weekly article -- just as I do:)
The early reaction to earnings. We will know a lot more about this next week, but the early indication is intense skepticism. There seems to be a negative tone.
Small business reactions and forecasts remain negative, especially from the highly partisan National Federation of Independent Businesses (NFIB). Here is a nice account from GEI, and a chart from Doug Short:

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

This week's award goes to Cardiff Garcia at FTAlphaville for his thoughtful and reasonable analysis of the housing turnaround. It started with Roger Altman's op-ed piece in the FT has a nice explanation of why A housing boom will lift the US economy.

This is an unpopular viewpoint, so the mocking tweets started. Garcia waded into the fray with a well-timed and data-filled rebuttal. Rather than attempting a summary which could not do justice to the original post, I urge you to read it. This topic is absolutely crucial to understanding economic prospects.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

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.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.

The ECRI recession call is now over a year old. Many have forgotten that at the time of the original prediction, the ECRI claimed that the recession was already underway by September of 2011. See New Deal Democrat's carefully documented discussion, including the original video, at the Bonddad Blog.

The ECRI keeps moving the goal posts on this prediction, suggesting that we will only know about a recession after many months because the data will be revised lower. For the few die-hards who are still taking this seriously, you should read the careful, thoughtful, and data-driven work from Dwaine Van Vuuren. He is taking up the key elements in determining recessions and looking at whether revisions affected the timing of past recessions. He does this by comparing the difference between the original observations and the final revised version.

Please note that Dwaine has actually done this research, while the ECRI has not supported its claims.

Here is a key chart on employment:

Dwaine's observations:

"The first is that the real-time data results in several false positives (false alarms) as indicated by the “1″ markings. The second observation is that for the most part, the signalling of the start of recessions is near-identical between the real-time and revised versions of the growth rate. The only exceptions are 2008 (tagged “2″), 1957 and 1959 where the revised data signalled recession earlier (meaning the real-time observer would have been late in his/her assessment that a recession was indeed underway) and point “3″ where the real-time data was actually earlier in signalling recession.
On the whole, the revised data provided earlier signalling 2 more times than the real-time data, giving it a slight edge. Whilst revised data results in a 3-month smoothed growth rate that can differ to that of the real-time growth rate, that difference seems to be isolated to the expansions and contractions, but not so much around the turning points themselves."

Dwaine's RecessionAlert service offers a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy.

Doug Short's most recent update asks, ECRI Weekly Leading Indicators: Time to Recant the Recession Call? Doug has been an open-minded monitor of the various arguments, so his analysis deserves respect. I do question his premise this week, however. Rather than recanting the recession call, I think that the ECRI should predict the end of the recession. After all, the ECRI said that we were in a new economic era of slow growth and more frequent recessions. Their WLI has turned higher, which everyone following their data sees as good news. Maybe it is time for them to "predict" that the recession will end within the next few months!

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

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. This week we continued our neutral forecast. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings have continued to drift lower. The penalty box percentage measures our confidence in the forecast. That indicator is moving higher, indicating less confidence in the neutral rating. It has been a close call over the last few weeks, as the ratings moved out of bullish territory.

The Week Ahead

This week brings plenty of economic data, and much, much more.

The "A List" includes the following:

The next Presidential debate (T). Playing to undecided voters in swing states.
Initial jobless claims (Th). Extra interest after last week's "mystery" decline.
Building permits (W). The best leading indicator for housing.
Chinese GDP (W).

The "B" List" includes these entries:

Retail sales (M). Confirmation of solid consumer confidence?
Industrial production (T). Important component of economic growth.
Housing starts (W). Widely followed, but volatile.
Leading indicators (Th). A favorite recession indicator for some.
Existing home sales (F). Will the bottoming in housing continue?

The other news includes regional Fed surveys from NY and Philly. I put little stock in these, but a big surprise moves the market. We also have European leaders meeting at the end of the week. and some Fed speeches.

The most important news will be earnings!

Trading Time Frame

Felix has continued the neutral posture of the last few weeks. It has been a close call between neutral and bullish for several weeks. Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have moved lower again this week, and we are now down to one trading position, as I predicted last week. We might be completely in cash by the end of this week.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance. Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Many have been out of the market and worry that they have missed the rally. A few months ago there were too many worries for them to invest. Now there is a fresh supply.

The traders (including Felix) are getting more cautious for a variety of reasons. Some are trying to lock in profits to earn their bonuses. Investors face a completely different problem.

Take what the market is giving you!

If you have been following our regular advice, you have done the following, in a proportion appropriate for your individual circumstances:

Replaced your bond mutual funds with individual bonds (bond funds are very risky!)
Sold some calls against your modest dividend stocks to enhance yield to the 10% range.
Added some octane with a reasonable allocation of good stocks.

These opportunities are still available, but it might be a limited time offer. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback. We have a good discussion going on bonds versus funds, and I plan a separate article that will provide a further forum.)

Final Thoughts on Earnings Season

Last week I noted that we were entering the season of fear. There was definitely a change in tone last week, with little response to good news. Stocks had the worst week in months while the data were actually somewhat positive.

Thousands of companies will report earnings in the next few weeks. When the overall earnings story is mixed, we can expect many to present a downbeat outlook. There is little reason to make bold predictions. Executives can be cautious, citing problems in Europe, China, and Washington.

The actual earnings "beat rate" will probably be close to historical norms, but the short-term outlook depends on psychology and trader sentiment. Just as it did last week, this can change swiftly.

This is why agile traders can afford to be cautious, while investors should be seizing opportunities.

October 13, 2012 in Housing Issues, Individual Investors, Interpreting Data, Markets, The Week Ahead | Permalink | Comments (6) | TrackBack (0)

September 02, 2012

Weighing the Week Ahead: What to do about Jobs?

From start to finish, the coming week will have a heightened focus on employment. Labor Day weekend in a presidential election year provides the obvious backdrop. Stubbornly high unemployment and sluggish economic growth underscore the issue of greatest concern.

This popular chart from Calculated Risk shows the nature of this recovery, described in terms of employment. So little accomplished, and so far, so far to go....

What are the solutions? Republicans contend that Obama policies, even augmented by aggressive Fed action, have failed. Expect the Democrats to use their convention to blame Congress.

The week culminates with the monthly employment situation report for August. It is more important than ever, since most see the data as significant in determining the Fed's next move.

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events. My theme is an expert guess about 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.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting 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

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

There was very little data last week, and the news was open to varying interpretations.

Bernanke threads the needle. The Fed Chair did better than I forecast last week, since I thought that anything less than a clear policy statement would disappoint markets. He did enough hinting to satisfy, while making it clear that more data is needed. Of the many discussions of his speech, I want to emphasize those most helpful for investors. I like the discussion in The Economist and also the interpretation from Jon Hilsenrath. For those of us who are interested in what we expect to happen, we should respect the conclusion:

Mr. Bernanke acknowledged some of the hurdles he faces, noting, "It is true that nontraditional policies are relatively more difficulty to apply," he said.

But he left little doubt that he sees the benefits of trying. "Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation," he said, "and it is important to achieve further progress, particularly in the labor market."

Rail traffic is at a four-year high (via Todd Sullivan).
Sentiment via the AAII survey, has backed off from excessively bullish levels. On a contrarian basis, this is positive.
ECB President Draghi skipped the Jackson Hole Symposium. The market saw this as good news as participants concluded that the ECB team was hard at work on a specific proposal for next week. We shall see about that, but the stories on this front got a positive reaction.
Housing is showing strength. S&P's David Blitzer calls it a "significant turn." Still only back to the 1999 or 2000 levels in real terms, the nominal prices do show an uptick. See Calculated Risk for the expected fine analysis and several charts.

The Bad

There was negative news, but fairly modest in overall significance.

GM idling Volt plant for four weeks, beginning September 17th. The July employment data was positively influenced because the traditional summer plant closings did not take place. This plant involves only about 1200 workers (who will receive 90% of normal pay from unemployment compensation). For those of us watching employment data, it is something to note.
Spain continues to delay in asking for help. The market reacts negatively, since it delays the process. It is rational for Spain, since the objective is to get the best possible terms. They want to see the ECB proposal.
The Bundesbank's Jens Weidmann is threatening to resign over expanded ECB bond buying. This is a natural response, and a good bargaining posture. Chancellor Merkel has urged him to stay on the board and make his views clear.
More bad news on China's economic growth as the 'flash" PMI "collapses" and hits a nine-month low. We all want to get the best data on China. The flash index differs from official data. Actual consumption of key inputs may differ from either of these surveys. One key input is iron ore, so I was intrigued by the thoughtful analysis from the FT's Izabella Kaminska, Iron ore, an alternative view. There is an intriguing analysis of the data and some good charts. China watchers -- and that should be all of us -- need more reporting like this.
Consumer Confidence (via the Conference Board) was weaker. Here is the long-term chart from Bespoke. The University of Michigan report was slightly better than expectations.

The Ugly

Individual investor knowledge. The SEC studied this by doing some tests with fake fund prospectuses. They discovered that investors did not even grasp the basics. Donald Marron has a good account of the study.

Meanwhile, there is an increase in day trading among individual investors.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

This week's award goes to Todd Sullivan, who has some great insight on employment and the economy.

His work qualifies for the Silver Bullet because so many prominent pundits have been completely wrong on this subject. He fearlessly takes on the big names like the ECRI, David Rosenberg, Nouriel Roubini, and Nassim Taleb.

He highlights the most important aspect of the discouraging employment picture, the drag from the continuing loss of government jobs. If you view the data in terms of private employment growth, the picture is quite different.

Todd's analysis should help anyone who wants a complete picture of the sources of sluggish growth.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."

The evidence against the ECRI recession forecast continues to mount. It is disappointing that those with the best forecasting records get so much less media attention. The idea that a recession has already started is losing credibility with most observers. I urge readers to check out the list of excellent updates from prior posts.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's article, ECRI's Embarrassing Recession Call, describes the complete history, the critics, and how it has played out. The article highlights the most important economic indicators used in identifying recessions, showing that none have rolled over.

The Bonddad Blog also has a good post on this theme.

With the release of personal income this morning, we now know the values of all four series thought to guide the NBER's recession dating decisions. While all of these series are subject to revisions, of course, as of now the simple fact is that all four rose in July, and three of the four are at post-recession records. So unless they are revised significantly downward, the simple fact is that no new recession started in July.

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. This week we switched to neutral. We have been bullish since June 23rd, with a one-week move to neutral a month ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved lower, and the confidence has deteriorated from last week.

The Week Ahead

While there will be fewer reports this week, the news will be especially significant.

The "A List" is all about jobs:

The monthly employment situation report (F) will be important for markets, the Fed, and the political campaign.
Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
ADP (Th) releases private employment data.
The ECB provides more information on its bond-buying plans (Th).
The ISM reports on manufacturing (T).

The "B List" includes three reports:

ISM services (Th).
Construction spending (W).
Auto sales (W).

The Democratic convention will also provide plenty of additional discussion about jobs.

Trading Time Frame

Our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. As the tape has improved, the ratings from Felix have gotten stronger.

Felix does not try to call tops and bottoms, but keeps us on the right side of major moves. We had one "neutral" forecast about a month ago, but things never got weak enough to reduce positions. The ratings are weaker, but there are still several attractive sectors to own.

Investor Time Frame

Sources continue to highlight the overbought nature of pure dividend stocks. This week Bespoke described August returns for stocks with different yields.

Dividend investing is fine, but you must look past the dividend yield and study the earnings, earnings growth rate, cash flow, balance sheet, and payout ratio.

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;
Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
Added some octane with a reasonable input of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

If you have not done so, it is certainly not too late. We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments welcome!)

Final Thoughts on Employment

I am not expecting a strong employment report. (I'll do my regular monthly preview at mid-week). Because of the expectation of Fed action, the impact of the report may be dampened. Real weakness will be seen as confirming Fed action.

It has been a confusing year, even for professionals.

Traders, according to CNBC's Bob Pisani have been under-invested and wrong throughout the year. He writes as follows:

Oh, and did I mention that 90 percent of the traders I know are underperforming the S&P 500, which is up 12 percent this year?
"There is something lurking out there ... we cannot continue to have central bank stimulation forever, with more debt layered on more debt," one trader said to me. He, too, is underperforming. "I'm long 20 percent of what I would normally be long in a market like this. I gotta own it because my neighbor owns it, that's a silly investment concept, but it's worked this year," he said.

He also notes that 90% of traders expect an imminent correction of 10%, something that he sees as a contrarian indicator.

Top strategists are also pretty bearish. Bespoke reports on the year-end price targets. Check out the full article to see how little these have changed throughout the year.

Part of the explanation is that traders and strategists both seem to have focused too much on the obvious problems and under-estimated the resolve and power of governments and central banks. Nearly every commentary on the Fed emphasizes the author's opinion of what policy should be.

Those of us who focus instead on understanding and predicting policy decisions, regardless of our personal views, have a real advantage.

This will get increasingly difficult in the weeks before the election.

September 02, 2012 in Government, Housing Issues, Individual Investors, Markets, The Week Ahead | Permalink | Comments (5) | TrackBack (0)

August 18, 2012

Weighing the Week Ahead: A Lull Before the Storm?

The official calendar is pretty quiet. Earnings season is over. Politicians are on vacation in the US and European leaders are just returning.

Beginning with the annual Kansas City Fed gathering at Jackson Hole and proceeding through a series of meetings in Europe, and the US political conventions, we will have a flurry of activity by key policymakers. Calculated Risk has a nice, long-term calendar of these events.

Here are the questions that could have the biggest market effects:

Will the Fed initiate another round of QE at the September meeting?
Will European leaders (including various institutions like the German Supreme Court) take more aggressive action to help the periphery countries?
How might the US election affect stocks and specific market sectors?

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

There was quite a bit of economic data last week, and it had a generally positive tone.

The economic surprise index from Citigroup is reversing the recent decline (via Cullen Roche).
Building permits are very strong. This is important, since a rebound in housing would really help the economy after a multi-year drag. Steven Hansen has a good analysis.

Inflation data remained tame. The CPI charts are not very interesting, and the Fed expects to be on hold for years. I prefer to look at Doug Short's CPI components. This will help us predict future Fed actions.

Good news on profit margins, from Doug Short's innovative comparison of indicators.
Leading Economic indicators from the Conference Board turned nicely higher.
Retail sales spiked higher. This is good news and important since it is the only one of the major recession indicators that has turned lower in recent months. We still need more data to have real confidence. Shortly after the announcement, the typical bogus story made the rounds: The entire gain was the result of fictitious seasonal adjustments, out of line with anything from the last ten years.

[rant on]

I have tried to explain the pernicious effect of sources that have no clue about data analysis -- no one who has actually done a seasonal adjustment. The story often starts with a site that is bigger than any of the reputable bloggers -- bigger than Barry or Calculated Risk. The story is immediately repeated on dozens of other sites. It is repeated on CNBC.

There is a huge market for fear and conspiracy. Each week I get reader inquiries about some bogus chart, but I cannot be a one-man truth squad. There is only one of me, and there are many Tyler Durdens!

On this particular topic, there is an obvious answer. Retail sales are seasonally adjusted for the number of weekends. It is just what you and I would do if we looked at a long data history, since weekends make a difference. July 2012 had only four weekends instead of five. Also the 4th of July was mid-week, affecting travel and other factors. The conspiracy site chopped off their analysis at ten years. If one of the several Tyler Durdens had wanted to be honest, he would have looked back two more years, where there were 4 1/2 weekend days and mid-week holidays. It takes very little effort to be honest, but apparently that is not the way to become the leading financial blog, so they chop their analysis without including the relevant years.

Here are the adjustment factors. See for yourself by looking back to 2001. Here is a source doing an honest job on the adjustments.

Also, you should note that seasonal adjustments net to zero over the course of a year. Why doesn't Tyler ever highlight the times the adjustments suggest better data?

And finally, there is no conspiracy. Government statisticians cannot change the procedures in a heartbeat to make things look better. Sheesh! This is so aggravating. So many people are being duped -- including those who should know better. This stuff is repeated via email, mostly because it fits the bearish pre-disposition.

[rant off]

The Bad

The was a little negative news.

Gasoline prices moved higher, up another seven cents and higher than a year ago (via Bonddad, with other high frequency indicators as well). This implies less discretionary spending for the average consumer.
The earnings beat rate drifted south as did that for revenues. Bespoke has the story and great charts. I am showing the revenue chart, which reflects Europe effects. We should all note that part of the reason that revenue is worse than earnings it the currency effect. Companies with significant foreign revenues also have lower costs. Scott Rothbort, who writes a great daily column at Wall Street All Stars (subscription required, but I have some discounts available so write me if interested), noted this effect, which seems to have eluded the general punditry.

Facebook after the lockup (preventing insider sales) expired Bad for those who bought the IPO and also for individual investor confidence. Abnormal Returns had a great post exploring the nuances of this experience. Everyone appreciates the daily links from AR, but when Tadas has the time for this type of story, it is especially helpful. Bespoke has a dramatic chart, comparing to Google at the IPO stage.

The drought. Some readers have taken me up on my invitation to comment, wondering why I have not featured this bad news. I agree that the drought is bad on many fronts. The problem in fitting it into my weekly series is "when?" We have a short-term focus. But I agree. Barry Ritholtz has an excellent post with great charts. Take a look.
Regional Fed surveys were poor. I do not regard these as very important, but I do emphasize the ISM survey. Calculated Risk explains why I should pay attention -- a good correlation.

There may be real demographic limits on GDP growth -- demographics and productivity. Kate Mackenzie at the FT has a fine article explaining this problem.
Unemployment might be much worse this month (via the Gallup Poll).

The Ugly

Financial fraud. This time it is Peregrine Financial -- a guy in Iowa. It is difficult for honest advisors when the stories of fraud keep pouring in.

Eddy Elfenbein has a great post on how to spot these frauds. Here are the key elements:

"Specifically, [investors] should learn to recognize Ponzi schemes, of both the Waserdorf and the Bernie Madoff variety. These schemes have several tell-tale traits:

They promise minimum or steady returns;

They claim their opportunities are exclusive, available only to a select few;

Their means of making money is too complicated or secret to explain;

They make it difficult to withdraw your money, saying that funds have been frozen;

They issue statements that lack detail, or that frequently show discrepancies that cannot be explained;

They are frequently run by a single individual whose charm and charisma allow him maximum leverage over investors’ fears—and greed."

Reputable advisors participate with a major brokerage where you can check your positions online and have full insurance protection. Mailed statements need to be verified.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

I was trying to earn my own award this week by alerting investors to bogus stories on election correlations. I decided to write an outrageous headline and follow a silly premise, explaining the "rest of the story" in the conclusion.

While many readers enjoyed the approach, many others did not read past the headline and the first few paragraphs. Humor and irony are difficult to achieve online. After seeing the reaction, I was reminded of Doug Kass's April Fools joke in 2008. At the time he had been pretty bearish, but he flipped bullish in the joke article. The story was actually picked up by clueless editors at major news sources.

If you look at my story, please keep in mind that I am trying to illustrate a point on statistical inference, not something about politics!

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread.

Bob and I did some videos last week explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the ECRI call and the ongoing debate is Doug Short, who has a complete and balanced story with frequent updates.

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. This week we continued as bullish. We have been bullish since June 23rd, with a one-week move to neutral a few weeks ago. These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings are higher, and the confidence is improving.

The Week Ahead

There is not much to look for in terms of economic data this week.

The big item will be initial jobless claims on Thursday.

Housing data include existing and new home sales on Wednesday and Thursday. We also get the FHFA home price report, although this gets less attention than the competing measures. Friday brings the durable goods report.

There will be Fed news, with speeches by two regional bank presidents (Lockhart and Evans) on Tuesday and Wednesday, and the FOMC minutes on Wednesday. There has been some market reaction to various Fed commentary in recent weeks, mostly for hints of another round of QE.

Angela Merkel, mostly late in the week, will have meetings with leaders from Greece, France, and the head of the eurozone finance ministers. Nothing definite will be decided, but everyone is interested in the German position toward both bailouts and ECB bond purchases.

I am expecting a quiet week, but with so much interest in Fed and European policy, expect pundits to pounce on any hints.

Trading Time Frame

Our trading positions continued in fully invested mode last week. Felix became more aggressive in a timely fashion, near the start of the recent rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. As the tape has improved, the ratings from Felix have gotten stronger.

Felix does not try to call tops and bottoms, but keeps us on the right side of major moves.

Investor Time Frame

A problem with market timing is the wide variety of methods with varying conclusions. This week I saw an interesting and unusual contrast.

Morgan Stanley's Adam Parker is sticking with his forecast for the S&P 500 to close the year at 1167, a decline of nearly 18% before the end of the year.
Georg Vrba, whose excellent work on recession forecasting has helped our readers, has two different market-timing methods. His most recent article explains that the next great bull market might already be here.

The interesting contrast is that Parker uses forward earnings and Vrba uses backward-looking Shiller data! You should read both articles to see the rationale.

Which of them is right? A great deal depends upon what is already anticipated by the markets. The average investor reads the financial news and thinks that gives him an edge. That only tells him what everyone else knows and is worried about.

Scott Grannis raises a great question: What if something goes right?

In short, if you don't know that the world is beset with problems and threats of mega proportions, then you just haven't been paying attention. And if you have been paying attention, you're extremely worried about all the things that could wrong, and it's a good bet that your portfolio is extremely conservative. The charts above tell the story: for the past three years, investors have been pulling money out of equity funds and stuffing it into the relatively safety of bond funds, despite the ongoing rise in equity prices. Markets everywhere are depressed because of all the concerns over all the things that might go wrong. Forecasts for future growth range from a depression to, at best, 2.5-3% real growth. Contrarians take note: no one is forecasting growth in excess of 3-4%.

If you have been following our regular advice, you have done the following:

Replaced your bond mutual funds with individual bonds;
Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
Added some octane with a reasonable input of good stocks.

There is nothing more satisfying than collecting good returns in a sideways market.

Beware of "pure dividend stocks", as explained by Bespoke.

Final Thoughts on the Lull and the Storm

Here are a few fearless forecasts.

The Fed will act, but not another round of quantitative easing. They might link action to actual lending by member banks and/or quit paying interest on reserves. The problem is increasing the money supply, so that might be the focus.

Europe will continue the incremental progress toward the final solution, a patchwork compromise that is not a plan. It will be the result of a process. The epiphany for investors will come when it is too late for most.

Nothing in the political campaign will be helpful for markets. The fiscal cliff will be with us until after the election, as will the resulting anticipation and fear.

August 18, 2012 in Housing Issues, Individual Investors, Interpreting Data, Recession Series, Reviewing Pundits, The Week Ahead, Trading | Permalink | Comments (6) | TrackBack (0)

June 30, 2012

Weighing the Week Ahead: Fireworks in the Forecast?

Forecasting fireworks this week should be pretty safe!

I will have trouble outdoing last week's WTWA theme: Upside Surprises. Nearly everyone in the comments disagreed with me. Sentiment is so negative that you can hardly get a good discussion about what might go right.

We could have more fireworks this week, and not just those on the 4th. Friday is shaping up to be a big day, with expectations for employment gains pretty low.

Background

The current climate is a torture test for the average investor!

It invites people to act on their least-effective instincts, leading to the worst results. I tried to explain why this happens in an article last week about those who "explain" the message of the market. The key point is that most pundits talk about things after the fact and pretend that they predicted it. Contrast this with last week where I was pretty much alone in suggesting that things might go right.

In sharp contrast, if you look at the markets objectively, most of the big-shot pundits have been proven wrong:

Wrong on recession forecasts - -made as imminent and unavoidable over nine months ago;
Wrong on earnings and profit margins -- a multi-year prediction of disaster;
Wrong on Europe;
And soon to be wrong on upcoming worries like the "fiscal cliff."

I love Barry Ritholtz's blast from the past. He questions the current worries about "uncertainty" and compares it to the cold war era. We both remember that time. Most people thought that their lives would end from a nuclear war. Can things possibly be worse now? He wisely notes that markets thrive on uncertainty.

This is a nice way of describing the "wall of worry" concept that many investors have found to be a valuable idea (0nce they get it).

The fireworks this week may illuminate events and reduce uncertainty. Only losers will wait for all of the answers. It is not that easy!

I'll offer some more thoughts on this in the conclusion, but first let's do our regular review of the events and data from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events. With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros. There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events. My theme is an expert guess about 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.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting 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

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The most important news of the week was very good.

Important steps in Europe. Last week's EU Summit significantly reduces the immediate contagion threat that has affected US stocks. It improves prospects for European economic growth. It demonstrates that the process of negotiation and compromise is working. This is exactly what I have been predicting for over a year -- a process of incremental change with concessions by many parties. The next thing to expect is more action by the ECB as well as the IMF and others. (See here for past articles with more detail on what to expect).
Congress passed legislation on transportation and student loans. It was a bipartisan effort with significant margins. Now what about that fiscal cliff?
US household deleveraging is nearly over. It shows a path that Europe could follow. The result is potential for spending if confidence improves. The entire Scott Grannis article deserves attention and you should enjoy the great charts. Here is a key quote:

"In any event, households' aggregate debt and financial burdens are now about as low as they have been for the past three decades. That amounts to some considerable adjustments, and I would argue that these adjustments have set the stage for some big changes in the years to come. For example, if confidence in the future increases, households' risk aversion is likely to decline, and the demand for money is likely to decline as well. There are trillions of dollars in savings deposits that households could decide to spend."

New home sales are stronger. Bill McBride at Calculated Risk has taken the lead on forecasting this. He is not getting carried away on the rate of the rebound. It is the thoughtful and careful analysis that you would expect from him. I also like Steven Hansen's discussion. My own role is in helping investors find the best sources. The key point to keep in mind is that just getting a bottom in housing -- not a rebound -- will help GDP by 1 to 1.5%.

...and by the way, for those who expect an avalanche of foreclosure homes on the market, Bill does not see that either.

Rail traffic was good, if one adjusts for the coal distortion. Todd Sullivan has an innovative chart on a topic we have reviewed on past weeks.

US Consumers have another $250 billion to spend through reduced energy costs. Great analysis from Prof. James Hamilton.

The Bad

Most of the economic data was a little weaker than expected. This continues the pattern of sluggish growth we have seen for several months.

Initial jobless claims remain at the 385K level. This rate of job loss is inconsistent with more robust growth and solid net job gains. (contra - Scott Grannis looks at year-over-year and sees nothing close to recession levels).
Personal consumption is weakening. See Steven Hansen's balanced analysis of all factors and also note the contrast with the deleveraging cited in the good news.
Corporate profits fell last quarter for the first time since the recession -- on a seasonally adjusted basis. (via Catherine Rampell in the NYT).
Consumer confidence remains weak -- in spite of falling gasoline prices. This suggests continuing weak employment, concern about poor policy decisions, or both. There are many charts of this, but I prefer Doug Short's analysis. It compares the principal confidence measures and also shows past recessions. Here is the Conference Board chart:

US Consumers are bearish on stocks via Bespoke. This impacts spending, so it is not contrarian.

Earnings estimates are declining. The Q212 forecast now calls for a decline of 1.1% via Bespoke.

Dr. Ed shows the impact on forward earnings.

The estimates are a bit lower, but there are still solid growth forecasts for the year. This bears watching.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon. We are working on a modification that will make this method even more sensitive. None of the recession methods are worrisome. Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are also not close to a recession signal.

There is a lot of activity from the recession forecasters. The basic summary is that those with the best records still see little chance of a recession in the next six months or so. The people that get featured in the press and on TV are sticking by their guns, even though the evidence is mounting against them.

We are now at the end of the nine-month forecast window that the ECRI adjusted to after their September, 2011 call (recession imminent, maybe already here, and unavoidable) seemed to prove wrong. Since then they have been adjusting indicators and trying to extend the window, which supposedly ends right now -- mid-year 2012. Here are some good updates:

The Bonddad Blog notes the failure of the ECRI forecast.
Georg Vrba asks whether the ECRI is still relevant. Great analysis and charts.
Doug Short has the latest economic forecasts. (look for the charts we have come to expect).
Doug Short has an ongoing analysis of the ECRI call, including evidence from various sources. This is the single best source for updates, including a weekly chart of the ECRI leading index and comparison to other sources.

There are many threads on this theme, and I am overdue for a full update. I'll try to bring them together.

The Week Ahead

Last week was one of our best in identifying both the focus and the potential outcomes. This week is very different. For many firms the "A Team" will be on vacation. Some will take five days off going through the mid-week holiday. Others will take five days starting with Wednesday. Still others will take all week! Here at "A Dash" we'll be on duty all week:)

This may dampen trading activity. Monday morning will provide the ISM manufacturing index, which is an important indicator. Then things will get quiet until Thursday.

On Thursday we will get the ECB rate decision, ADP private payrolls, and initial jobless claims. Friday will bring the employment situation report.

To summarize, the fireworks will come on Thursday and Friday.

Trading Time Frame

Our trading positions geared up last week. After Monday we were fully invested. Felix is not a range trader, but is excellent at getting on the right side for big moves. As I predicted last week, this was the week of opportunity for trading.

Investor Time Frame

The successful investment strategy differs markedly from trading. It is especially important to establish good, long-term positions when prices are favorable. I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look. You can contrast this with the many pundits who claim miracles of market timing.

The best strategy through the various gyrations has been buying dividend stocks and selling calls for enhanced yield. Anyone unhappy with bonds should be doing this for a yield of 8-10% with greater safety than pure stock ownership. Take what the market is offering!

Final Thoughts on Fireworks

This week marks an especially important time for most individual investors. While my audience includes traders and investment advisors, it is the individual investor who is most likely to be led astray. I often try to write as if I were speaking directly to one of my clients or friends, face-to face. I relate to their biggest fears and try to provide some reassurance.

Here is the dilemma:

The best investment advice comes from contrarian approaches.

Most investors pay too much attention to recent results.

This provides a challenge for investment advisors.

When I interview a new client, I have six different programs available. They all beat their benchmarkrs on a long-term basis, but they differ widely in risk and reward. To take two simple examples:

If you want to make 8-9% a year with reduced risk, I have a program for that.
If you want complete safety, we can do that also.

These are not the right moves for most people who have a longer time horizon. Even older investors need a touch of octane in the tank!

And that is where we are right now. Most of the people you read or see on TV are looking at the past and pretending -- bad advice.

While I do not give specific investment advice on the blog, my general assessment is that each investor should be a little more aggressive than usual (adjusted for personal circumstances). When I speak with individuals, I find that most are scared witless (TM OldProf euphemism), and therefore not prepared to participate in the upcoming rally as problems are solved.

This week is a good example.

Best Investment Advice of the Week

For my strongest advice this week I recommend Matt Busigin's first rate article, The REAL Cult Of Equity.

This is the single best piece I saw last week, and I read hundreds of articles. Take a few minutes. No, take more than a few minutes and read it twice.

Matt covers the key quesitons about whether we are in a recession, why stocks are cheap, the risk/reward for stocks, and some refutation about those "bad times to invest" guys -- although he is too polite to name them.

He is especially powerful in explaining marginal forces on asset allocation -- something totally ignored by most pundits. Here is one example:

If the chart seems a little wonky and does not make immediate sense to you, all the more reason to read the article. You will see why! (It shows the powerful mean reversion of stocks and bonds -- a key concept).

June 30, 2012 in Contrarian Investing, Europe, Forecasting, Housing Issues, Individual Investors, Interpreting Data, Market Valuation, Markets, Recession Series, The Week Ahead, Trading | Permalink | Comments (3) | TrackBack (0)

June 23, 2012

Weighing the Week Ahead: Time for some surprises?

When nearly everything you see or read seems to carry the same message, it is time to take a deeper look. The mainstream thought now seems to include an obligatory nod to the "mess in Europe" featuring their clueless leaders, the fiscal cliff, the recessionary US economy, and the upcoming hard landing in China.

Wow! It does not take much to convince the punditry that investors should all step aside until after the election.

It is reminiscent of early 2009, when everyone searched to explain relentless selling in the absence of any fresh news. I started writing a four-part series and only finished three before things changed.

When it is least expected, something might go right.

I'll offer some more thoughts on this in the conclusion, but first let's do our regular review of the events and data from last week.

Background on "Weighing the Week Ahead"

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The US economic data last week was actually pretty good.

The Greek election was the best possible news, opening the way for a reasonable compromise solution. The New Athenian is a great source, covering the various possible outcomes.
The Fed paved the way for further action. The official policy extended Operation Twist as I (and most others) expected. In the press conference (apparently ignored by many who heard what they wanted to hear) Bernanke was quite clear in stating that the Fed would not be stopped by politics. The disparity between the economic forecasts and stated objectives is clear -- the subject of several questions. Bill McBride at Calculated Risk thinks this means action at the August 1st meeting, but he notes that others see a further delay. See also top Fed watcher Tim Duy's analysis.
The Conference Board's leading indicators recorded a surprising gain of 0.3. See Steven Hansen's analysis.
The most important housing data showed strength -- especially building permits. (See Calculated Risk for the good charts and analysis. Bonus! Shadow demand is increasing).
The G20 meetings were positive for the Europe situation. The coverage of these meetings in the regular financial media is so bad that it is almost impossible to track the progress. If you want to track progress, you need to have good sources. Here is a key point from the Council on Foreign Relations:

'What were the main takeaways of the summit?

The two key takeaways are: first, the additional commitment of funds to the IMF by the large emerging markets, which indicates that they have accepted to continue a longer-term process of IMF quota reform, despite the Obama administration's inability to get Congressional approval for the 2010 agreement before the October 2012 deadline. Secondly, it is the detailed commitment of the euro area, which "will"--rather than intend, or should--"take all necessary measures to safeguard the integrity and stability of the area, improve the functioning of financial markets and break the feedback loop between sovereigns and banks."'

Sentiment is more negative than in early 2009 (via Bespoke).

Conditions in Europe have improved. You would never know this unless you looked at data instead of headlines! I read FT Alphaville to follow this news, and so should you. Spanish bond yields are the single simplest measure of progress:

Scott Grannis notes this as well as swap spreads, adding more good charts. He writes as follows:

"The 10 bps decline in swap spreads in the past week or so is impressive by itself, and more so since it takes swap spreads back to the levels of late July last year, when the Eurozone crisis was just beginning to heat up. The ECB's liquidity injections have managed to restore a lot of confidence and liquidity to the Eurozone financial market, and that is an essential first step to allowing the crisis to play itself out."

The Bad

Most of the economic news reflected weaker than expected results. This continues the pattern of sluggish growth we have seen for several months.

Even the highway bill despite bipartisan support, seems to be stalled.
Earnings estimates are falling. The Q212 estimates for the S&P 500 have declined dramatically (via Reuters). Dr. Ed. has a helpful chart showing the decline for the quarterly estimates. The overall estimate is still a healthy increase over last year, but it bears watching.

The Philly Fed Index had an alarming decline. For years I have expressed little confidence in this indicator -- one region, with no information on the sample, response rate, margin of error, etc. It also is a diffusion index, so it shows direction rather than level. We all know that the direction is lower. The market is pretty uncritical about this. See Steven Hansen's discussion for a comprehensive analysis and a lot more history.
Chinese Economic Data are Suspect. This is a repeat item from last week, but with new evidence. At the moment the concern is that the Chinese government (not known for Freedom of Information) might be overstating growth. Fair enough, but the motives and biases may not always be clear. There are many reasons for understating growth. They may simply wish to disguise motives, perhaps acquiring assets cheaply. Here at "A Dash" we are equal opportunity skeptics.
Home Loans are Declining, despite lower rates. The problem? Potential borrowers cannot qualify (from Dr. Ed.)

The Ugly

Are the Chinese taking over Toledo?

Actually, I don't think this is bad news, but it was sent to me by one of the many active emailers who make sure that investors are able to find the worst in anything. The story about foreign purchases of US real estate is an old one for veterans. A highlight is the Japanese purchase of the famous Pebble Beach Golf course in 1990.

As long as the US has a trade deficit, our trading partners will make investments in US assets.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

Tim Duy has a nice update on financial stress, including the SLFSI and some alternatives. He has expert analysis and helpful charts.

For comprehensive recession forecasting we recommend the RecessionAlert team. They have reverse-engineered the ECRI approach and improved on the recession forecasting power. Since they have not gotten the mainstream recognition they deserve, you can still enjoy the advantage from their methods. You should consider subscribing for more detailed reports covering various time frames and GDP forecasting. They have also initiated a new service -- the Shadow Weekly Leading Index. If you like the ECRI approach, you can get an advance read before their weekly announcement. The most recent take on the ECRI approach suggests a 37% recession probability. If there is no improvement, there might be a warning in two or three months -- still not close to the ECRI's own prediction.

Doug Short has a complete history of the ECRI call, updates from fresh data, a list of sources, and the famous Short Charts that you would expect.

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. This week we switched to "bullish." Last week we noted that the "neutral" call was marginal. Remember that these predictions, although made each week, are supposed to represent expectations over the upcoming month.

The Week Ahead

I was correct last week in my prediction both about the FOMC decision and the week-long focus. This week has more possible themes, including the Supreme Court decision on health care and speculation about the European Summit.

There are three housing reports including new home sales (Monday), Case-Shiller home prices (Tuesday), and pending home sales (Wednesday). Taken together with last week's housing data, these could be interesting.

In order of importance, we have the regular Thursday report on initial jobless claims, consumer confidence (Tuesday), personal income and spending (Friday), and durable goods (Wednesday). There are various regional Fed reports during the week, but they will be less important unless we get a big change like last week's Philly survey. The Chicago PMI is interesting as an early read on the national ISM number, especially when there is a weekend in between as is the case next week.

Trading Time Frame

Our trading positions were unchanged last week. We remain 2/3 invested in long positions. Felix is not a range trader, but is excellent at getting on the right side for big moves. There are several highly-rated sectors in the penalty box, while the inverse ETFs are at the bottom of the chart. I expect to add new long positions during the week.

Investor Time Frame

The big threat is for investors is the apparent safety of bond funds. The consensus expectation is that rates are rising, as shown in this clever and important chart from Doug Short:

Each line represents the forecasts for a new year. You can see that the consensus of economists expects interest rates to move much higher. Unless you think you are smarter, you might want to pay attention.

If that happens, I outlined last week why you should be worried about holding bond funds instead of individual bonds. It is the biggest investor threat right now.

Right now the market is giving you two things:

Plenty of great stocks that are as cheap as they were at the market bottom in 2009, on a price-to-earnings basis. To pick two examples, I buy Apple (AAPL) and Caterpillar (CAT) on day one for every new client. There are many others.
Good dividend stocks where you can sell short-term calls. I am doing this as a "bond substitute" providing the yield we need in a low-rate environment. I am targeting 8-9% returns on this approach, and achieving it through an up and down market cycle. You can, too, but it takes some work.

Investors who play these themes will do well, regardless of the headlines.

Final Thoughts on Possible Surprises

The investor quest for yield has taken sector valuations to extreme levels. Take a look at this chart from Bespoke.

No wonder we see tech stocks as cheap.

There are several sources for a surprise in the next few weeks.

The Supreme Court health care decision will provide clarity. Business leaders have complained about a lack of predictability. If the law is struck down, many will celebrate immediately and certain health sectors will rally. Even if it is maintained, the rules will be known.
Housing is showing signs of bottoming. Many forget that the economy will be 1 to 1.5% better on GDP merely by avoiding further declines. If the 2.25 million people under age 34 decide to move out of the basement and into their own homes, it will be even better.
European Summit decisions. Since the consensus now is that these are all meetings with no substantive progress, the stage is set for a surprise. Most US investors might be surprised to learn that the European leaders actually have access to all of the same information they have, via newspapers printed in other languages.
Increased confidence from lower fuel prices.

These are just the most obvious. Readers are invited to suggest other ideas. Please try for something new!

June 23, 2012 in Housing Issues, Individual Investors, The Week Ahead | Permalink | Comments (11) | TrackBack (0)

April 21, 2012

Weighing the Week Ahead: Will the Fed Disappoint the Markets?

Get ready for a week of renewed focus on the Fed. No one expects a policy change, but there is plenty of room for disappointment.

In the new era of Fed communications there will be plenty to analyze, including the following:

The FOMC statement, which can be carefully parsed for small wording changes and evidence of disagreement or dissent;
The updated economic outlook;
Updated projections from each FOMC member, with a report showing ranges and central tendencies;
A press conference where Bernanke will try to explain it all.

Most of this transparency is pretty new, and it is still controversial. One reason is obvious.

In the old days, when no one expected a policy change, there would be no reason for fixation on the Fed. There is now much more to analyze.

I'll offer my ideas on what to expect in the conclusion. First, let us do our regular review of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review. I single out what will be most important in the coming week. My theme is an expert guess about 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.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The general economic data continues to be a little soft, while earnings have been very good.

Building permits show solid growth. In my experience this is the best leading indicator. Steven Hansen does a nice job on this indicator, which the ECRI should probably consider including instead of housing measures obfuscated by foreclosures.
Earnings reports are very good so far, via Bespoke Investment Group. As you look at this, please keep in mind that many claimed that earnings estimates were too high and should be moved lower.

Earnings and revenues. One of my pet peeves is a general lack of accountability on earnings expectations. Remember when the earnings rebound started? Here is Dr. Ed Yardeni's account:

"When the bull market first started in 2009, the bears growled that the rebound in earnings was all attributable to cost cutting. So it wasn’t sustainable, in their opinion. They didn’t believe, and couldn’t imagine, that revenues might actually have a normal recovery too. I track three measures of business revenues, which are all at record highs now."

Rail traffic was solid if you ignore coal. Steven Hansen at GEI has been doing a great job with this series. This table tells the story -- solid except for coal.

Too much focus on the trees -- and neglecting the forest. We should all keep in mind the overall picture coming from creativity and innovation --- via Abnormal Returns and Barry Ritholtz.

The Bad

The economic news was disappointing, with everything a touch worse than expected. If the list is not enough for you, check out a source that even sees employment growth as bad (via Todd Sullivan).

Initial jobless claims moved higher, to 387K and revisions were also higher. The times include the final week for the April employment report. While many observers opine that this will be better when the unusual seasonal factors are resolved, I continue to be concerned about the jobs numbers in two weeks.
The Philly Fed was a bit light at 8.5 versus expectations in the 10 range and 12.5 last month.
Assorted political salvos. I hardly know where to start. Each party is proposing legislation that has no chance of passage. The GOP has a choke point in the House and also preventing 60 votes (required to block a filibuster) in the Senate. The President can veto any bill and the GOP has no chance of a 2/3 vote to override. I have a long list of links from last week, but I think it is better handled as a separate article. Let us just say that political debate is descending to the lowest common denominator (see here for examples). Jeb Bush warns to expect the most negative campaign ever.
Vehicle traffic has moved lower, especially with an adjustment for population. This is an interesting and creative indicator from Doug Short.

European debt continues to be worrisome. While the scheduled auctions met sales targets, the rates are high, so I am putting this in the "bad news" category. The Spanish 10-year note was trading at the 6% level and the Italian equivalent at about 5.5%. I monitor these daily. While I still believe in a broad compromise settlement involving many parties, there is obviously an attack in the CDS market. I encourage readers to check out Cam Hui's commentary. I invite other recommendations for good sources in the comments.

The Ugly

This week's Ugly award goes to the stock-picking robot -- ready to help you find instant gains in penny stocks. The economic and investment losses have created a new level of desperation. There is a dramatic increase in both perpetrators and victims.

The robot team had a business model that profited in all of the key ways:

Selling bogus software to clients. The software developers were told that the program needed to appear to be analyzing data, but actually taking direction from the scammers.
Selling pump-and-dump services to companies. Results guaranteed.
Front-running the suckers.

This is a constant battle. I want to give credit to the SEC, but it is frustrating. I have reported a number of obvious scams. The SEC does not let you know what happened. They do not even acknowledge your contribution. Two groups that I reported were the subject of later action, but some are still at large.

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon. Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are not close to a recession signal. For his subscribers, he offers the following conclusion:

"I now find myself in statistical opposition to all those who are calling for a cycle peak in 2012. I use the “statistical” qualifier in that sentence because after doing this for more years than I care to admit, one has to be cognizant of the fact that strange things can happen. So it is possible, but highly improbable, that the conditions associated with a cycle peak could present themselves before we “turn the page” on 2012."

Bob has his usual exhaustive analysis with many charts. His analysis is erudite, comprehensive, entertaining, and witty. Here is a single chart summary, but you should understand that all show the same thing.

I am a big fan of Dwaine van Vuuren, whose excellent statistical work is giving us better insight into a wide range of recession forecasting methods. The data point that I cite each week (the four-month recession outlook) is only one aspect of a comprehensive report. The SuperIndex includes nine different methods, including the ECRI. The analysis has a very strong, practical market application which has paid off richly for subscribers over the last few months. How? Mostly by putting the ECRI recession forecast into better perspective. I am publishing the one-month delayed Leading SuperIndex estimate of recession probability in the near future -- three or four months. This is plenty of time to have value for public followers of their reports.

Two weeks ago they added another interesting recession indicator, finding states that show economic changes in advance of the nation. You will be surprised at which states are the "canaries in the coal mine."

Last week Dwaine teamed with Georg Vrba to analyze the unemployment rate as a recession indicator. It turns out that this single measure has terrific results. It currently suggests, "One can therefore reasonably conclude, based on the historic evidence of these unemployment-based indicators, that there will be no recession in the near future and that ECRI’s recession call may have been premature."

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. This week we shifted from bearish back to neutral. The last several weeks have been pretty close calls. The ratings have improved a bit. The inverse ETFs are no longer at the top of the list, so I would not be surprised to see a little buying next 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. For daily ETF commentary from Felix, you can sign up for Wall Street All-Stars, where I still have a few discounted memberships available. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

While I expect the Fed to be the main story this week, there will be plenty of other action.

Before the trading week even starts, we will have the first round of the French elections. Normally this would not be a major consideration for US stocks, but this time is different. A loss by incumbent Sarkozy could lead to dramatically changed policies for France, with other countries in line. This could affect the euro, the European economy, and also US stocks. This Washington Post summary lays it out nicely. That will be Monday's story.

I am interested in Consumer Confidence (Tuesday) and Initial jobless claims (Thursday) as important coincident reads on the economy. Q1 GDP -- the first reading -- will be reported on Friday, presumably confirming that the economy weakened a bit but was not close to a recession.

This is the big week for housing data, including Case-Shiller prices, FHFA prices, new home sales, and pending home sales. Housing is important, of course, and some see signs of improvement. I am not expecting much from these reports.

It is also a big week for earnings reports. It could well be an exciting week.

And finally -- Tuesday will give us the BLS Business Dynamics Report. This is the one that shows whether the employment estimates from 8 months ago were accurate. Everyone should be watching this, but I will probably be the only one reporting!

Trading Time Frame

We were out of the market last week in trading accounts, after a long period when Felix caught the rally pretty well.

The current market has been confusing to many top professionals, as I reported last week in this article featuring commentary from Art Cashin.

Investor Time Frame

For investment accounts I have been buying on dips in stocks that we like. I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look.

Investors should not be trying to guess the next market move. Instead, take what the market is giving you. I have been offering this advice for months, and it led to a great quarter for anyone taking heed.

If you are an investor who has been frustrated by a market that ground relentlessly higher, providing no opportunity for entry ---- well--- what are you waiting for now?

I want to emphasize that being an investor does not mean "buy-and-hold" or a "forever" portfolio. I believe in active management of investment accounts, adjusting for changed circumstances. We need to look beyond the headlines, political commentary, and those profiting from the climate of fear.

There is an important difference between short-term market timing and active management of your holdings.

I look at the following:

Recession risk -- now very low.

Earnings growth -- excellent and undervalued.

Financial stress -- high on the headlines, but modest on the data, falling rapidly.

Barry Ritholtz has a great article on this distinction, which I strongly recommend. Inspired, I wrote my own piece on this theme. Find your role, your strategy, and stick to it!

If you are really worried, you can imitate our enhanced yield program. Buy good dividend stocks and sell short-term calls. I am targeting 8-9% returns on this approach, and achieving it no matter what the market is doing. You can, too.

Final Thoughts on the Fed

When I put on my trader hat, focusing on the attitudes of those on the front lines, I know what is important.

Traders want more of that QE!

The trading perspective is that the economy is weak and the Fed does not get it. Traders -- and therefore the "market" in the short term -- want to see the Fed doing more. At the most fundamental level there is no need for a deep explanation. The last two years show a pattern which (to a very forgiving eye) seems to show a market that rises when the Fed is active and declines when it is not.

While I disagree with this interpretation, success in trading means understanding the perspective of everyone else. The Fed policy has had much less impact than traders believe. Here is a helpful chart from Doug Short.

For investors, more twisting is not a big deal. For traders, it is.

April 21, 2012 in Europe, Fed Policy, Housing Issues, Individual Investors, Interpreting Data, Markets, The Week Ahead | Permalink | Comments (2) | TrackBack (0)

March 18, 2012

A Weighing the Week Ahead: Seeking Safety?

If you are looking for safety, you are not alone. Many people who lost money in stocks and real estate have become more risk averse. The problem?

They are looking for safety in all the wrong places!

Owners of (formerly AAA-rated) US debt experienced this last week. If you own a ten-year Treasury note, you lost 2.5% in market value as the yield increased 30 basis points in a few days. What if the yield moves to 3%, a level that is still quite low by historical standards? That would cost another 6%, or more than 8.5% in total. You will still get your investment back if you hold until maturity, but I suspect that many seeking safety might need access to these funds in the interim. (Check here to learn about bond pricing and use a free online calculator).

The same is true for bond funds, where the long bull market has created the impression that values can move only one way.

Gold investors also took it on the chin last week, losing 3.3%. Gold is attractive to two distinctly different camps: those expecting rampant inflation and those predicting a gloomy deflationary spiral with desperate consequences. Sometimes the sellers of gold (and fear) offer both propositions -- either in the alternative or simultaneously. Two years ago I described these as the "golden goal posts."

Right now the prospects for either alternative have been reduced, making gold less attractive. Since there is no fundamental method for valuing gold, the presence of these fears makes the difference. Right now the fear trade is not working, since the ball is going through the uprights.

I'll offer some suggestions about the search for safety in the conclusion. First, let's do our regular review of last week's news and economic data.

Background on "Weighing the Week Ahead"

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The news was mostly good last week.

Global earnings estimates are moving higher (via the FT). Eventually, this is the most important data point for investors.
Wall Street strategists are bearish. Bespoke has their expected great chart and this explanation:

If strategists as a whole were particularly prescient, this would be a bearish sign, but fortunately that's not the case. The peak recommended stock weighting came just after the peak of the Internet bubble in early 2001, while the lowest recommended weighting came just after the lows of the financial crisis.

Tame inflation data. As measured by the government, inflation is under control. The Fed seeks 2% inflation as a target consistent with its dual mandate of price stability and full employment. The current policy is designed to increase inflation expectations to that level to avoid what economists call a "liquidity trap." While many disagree with the economic theory and the policy, investors should accept the reality. Doug Short provides this fine chart of long-term inflation, as well as a discussion of some of the alternative viewpoints.

Initial jobless claims returned to the 350K range, the lowest since 2008. Calculated Risk has a helpful chart.

The Bad

There was also some bad news last week.

Budget deficits. The Obama budget has higher near-term deficits according to the CBO. This is a complex subject, since there is a trade-off of near-term deficits versus long-term savings. There are also assumptions about whether or not the Bush-era tax cuts are extended. Finally, we have ongoing debates about the debt limit compromise and whether one side or the other will look for a way to weasel out. Stay tuned!
Consumer sentiment (via the University of Michigan) is weaker. This was lower and missed expectations. I place a lot of emphasis on this series because of the excellent methodology, not because it is my school. This series usually informs us about employment, but currently includes political effects as well as high gas prices. Despite the issues, I regard this as important information and a cause for concern until it gets back to normal levels.
Industrial production was flat, missing expectations. There was only a small market reaction, but this is one of the factors followed by the NBER in dating recessions. Steven Hansen has a more positive take, focusing on manufacturing and de-emphasizing utilities. Here is the key chart.

More estimates on the impact of the Iran situation on the price of gas. This is worse than I have been citing, possibly as much as $6/gallon.
We are at a "Bradley turning point." Ordinarily I would not even mention this, but it is the latest cause celebre of the bearish punditry. Two of my favorite sources, Charles Kirk in his commentary, and my astute colleague at Wall Street All Stars, Bob Marcin, have mentioned this method. Neither endorses this approach, based upon the alignment of the stars, but both cite recent accuracy. As Charles notes in his members only commentary, if Friday turns out to be a market top, everyone on trading desks will be talking about this. [If it is not, there will soon be a new candidate. Time for another article along the lines of the Hindenburg Omen.]
Federal tax receipts are soft. Here is Dr. Ed's chart:

The Ugly

Campaign advertising! With the Illinois primary coming up on Tuesday, voter attention has turned from our last Governor (finally) starting his prison stretch with one more press conference, to the avalanche of attack ads interrupting the basketball.

There is a simple reason that political campaigns use these ads: They work! While voters claim to be high-minded, in fact these deceptive ads swing many opinions.

For an investment angle, you might compare this with advertising about Gold, a staple of certain talk shows, investment TV and radio, and commanding multiple-page spreads in the newspaper.

If so many people think they can get great investment ideas from ads on talk radio, what can we expect for their voting decisions?

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

This week continues two new measures for our table. The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon. (I know that I am behind schedule on this. The message remains comforting.)

The second is the SuperIndex from PowerStocks research. I am a big fan of Dwaine van Vuuren, whose excellent statistical work is giving us better insight into a wide range of recession forecasting methods. The data point that I cite each week (the four-month recession outlook) is only one aspect of a comprehensive report. The SuperIndex includes nine different methods, including the ECRI. The analysis has a very strong, practical market application which has paid off richly for subscribers over the last few months. How? Mostly by putting the ECRI recession forecast into better perspective.

Spend a few minutes at their site and you will see the following:

A description of the SuperIndex components and methods.
A collection of research reports, including how to improve the ECRI method, using the Conference Board's LEI, and deciding how much recession warning you need.
A sample report. This shows the richness of the weekly information, including differing time frames for recession warnings as well as an updated GDP forecast.

This is all driven by the most recent data from all of the indicators.

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. This week we are continuing our neutral vote, a position started last week, for the first time since December.

A Note on the Recession Outlook

We should note that the ECRI is still pounding the table on their recession forecast. Even if this eventually proves to be correct, the timing was terrible for investors who took heed right away, missing a 25% gain. I have been highlighting sources with better recession forecasts, including those that have better timing using the ECRI's own data.

My weekly review describes my conclusions. It is not a place where I develop an argument, so let us save that for later. Meanwhile, please read New Deal Democrat at The Bonddad Blog for a good analysis (calling BS) of the key issues. The ECRI has not responded to the many critics, and they get very polite questioning in interviews. It is past time for some real explaining.

The Week Ahead

This is not a big week for economic data other than housing. I covered my thoughts about housing a month ago, and nothing has changed. It is interesting that Calculated Risk thinks we might have a bottom. This week's Barron's had the housing rebound story on the cover.

There are a raft of housing releases. My focus will be building permits on Tuesday (a leading indicator) and new home sales on Friday.

Initial claims on Thursday is the most important weekly data series. We also get the latest version of the Conference Board's leading indicators, which are expected to remain positive.

Fed Chair Bernanke gives a couple of college lectures. Everyone will be watching for any policy hints, but don't hold your breath on that one.

There are some other Fed speeches.

To summarize, this is a week with little data, except for housing where nothing is likely to turn sentiment. It is a week as quiet as they come, and right after options expiration. Volatility has moved lower.

Trading Time Frame

Our trading accounts have been 100% invested since December. Felix caught the current rally quite well, buying in on December 19th. There are now only a few sectors in the buy range. The overall ratings have deteriorated. This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated. Felix has been more confident than I have been on the trading time frame, and has stayed invested in the face of a lot of skepticism. This illustrates the importance of watching objective indicators instead of headlines. Despite the weakening overall ratings, Felix kept us fully invested for trading accounts last week.

We have 28 sectors in the universe, so we can be fully invested if there are three strong sectors, even if the market overall is neutral or negative.

Investor Time Frame

Long-term investors should be aware of the rapid decline in 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," and is declining further. This sort of decline has been a good time to buy stocks on past occasions. Worry is still high, but has now declined to a more comfortable level.

Even though stock prices are higher than in October, the risks are much lower. I am increasing position size for risk-adjusted accounts. (We cut back by about 30%). I am also looking more aggressively for positions in new accounts.

Our Dynamic Asset Allocation model has become much less conservative. Gone are positions in bonds and gold. DAA responds to the message of the market, cashing in on extended moves. It is rather like what some call a "lazy portfolio" but better.

The Final Word on Safety

The most important question for any investor is the first one I ask of a prospective client: Do you need to preserve wealth or to create wealth?

Left to their own devices, many people mistakenly go "all in" or "all out" instead of thinking about the right answer.

Once deciding on a level of safety, it is time to consider the risks, including those often ignored:

Gradual inflation, of 3-4%. This will cut your purchasing power in half in twenty years. Owning stocks that reflect price increases can help.
Weaker dollar. This can also hurt your purchasing power, but can be offset by owning foreign stocks or US stocks with significant foreign exposure.
Rising energy prices. If you own some energy stocks, you can actually benefit from this trend.

There are other examples, but my point is to open minds to a reasonable level of stock ownership. This can be done through a very conservative plan of dividend stocks with enhanced yield or a more aggressive apporach. The key is matching your personal needs to a plan.

The traditional concepts of safety are fine for those who are preserving wealth. For the rest, this is an illusion.

March 18, 2012 in Housing Issues, Individual Investors, Reviewing Pundits, The Week Ahead, Trading | Permalink | Comments (0) | TrackBack (0)

February 19, 2012

Weighing the Week Ahead: Time for a Turn in Housing?

Since the start of the Great Recession there has been little reason for enthusiasm about the US housing market. The home construction industry and related sectors have been a continuing drag on the recovery.

In my circle of friends I know of several first-time home purchases in the last couple of years. I was reminded of this last night when visiting my niece and her husband, seeing their beautiful new urban home and enjoying a wonderful "Restaurant Week" dinner at a place new to us all. It is too easy for us stodgy old analysts to forget that successful young people want their own homes. For them, the time to buy is now.

Regular readers know that I embrace the illustrative power of the anecdote, but I live on data. Taking a look at this week's calendar, I expect more media attention to the prospects for improvement in housing.

With an open mind, no specific positions, and a multi-year record of skepticism on this sector, I am receptive to the question: Is it time for a turn in housing?

I'll look at this more deeply in the conclusion, but first, our regular look at the news and data from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review. You cannot read all of them. It is actually possible for your work to be counter-productive as I tried to explain in Read a Lot, Get Squat.

Instead of trying to drink from a fire hose, why not be more selective?

I single out what will be most important in the coming week. My theme is an expert guess about 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

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly.
It is better than expectations.

A valued reader, noting the high unemployment levels, asked how I can ever write about employment as "good." I agree that we are far below what is needed for economic health and general prosperity, but that is not my mission. I am explaining how events will be interpreted by the market. You might disagree on political or policy grounds, but that is not the subject. When the news is "less bad" it is market-friendly.

The Good

There was some very good news this week.

Initial jobless claims. This is important data, more current than most. The decrease in initial claims encourages us that the employment picture continues to improve. There is a lot of weekly noise, but the widely-followed four-week moving average is also very good. Ed Yardeni puts this in perspective, also questioning the PIMCO meme of the "new normal." He thinks it is the real normal, and you should read his thoughts.

Sentiment is more bearish. In the world of investing, this is bullish. Go figure! Here is the chart from The Bespoke Investment Group.

Leading Indicators are stronger. This is the Conference Board report, better despite the umpteenth adjustment. See Steven Hansen for a thoughtful analysis of this data series
Congress managed to extend the payroll tax cuts. Everyone is claiming credit.

The Bad

There was some bad economic news last week.

Greek debt is even worse than we thought. The IMF has an update. See Calculated Risk for some helpful analysis.
Fed POMO operations will be less aggressive. As regular readers know, I completely disagree with the POMO interpretation of the market. There is no logical connection. The charts are sloppy in starting and ending points. This source (HT Charles Kirk) is guilty on all counts, but I present it because it has had a major effect on traders. Self-fulfilling prophecy?
Inflation is a little hotter than we want. This is a tricky topic, since the Fed wants to see inflation of about 2% on PCE. The choice of the PCE as the index dates back to the Greenspan days. It is a more accurate read of what people buy, avoiding many of the housing issues, and it is less volatile. It has been the Fed choice even when the inflation rate was higher than the CPI. Doug Short does a great job of explaining this, including his matchless charts. Here's one:

The Ugly

The respected folks at the Gallup Poll report that employment looks much worse as of mid-February. I saw the interview on CNBC from my hotel room in Seattle, but I want to investigate further. Here is the Gallup chart:

This looks terrible. The report has already sparked a blogger debate (Mish and Bonddad). Someone may be getting our Silver Bullet award next week!

The Indicator Snapshot

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

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

This week continues two new measures for our table. The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain the link to the C-Score next week. (I now that I am behind schedule on this, especially with last week's travel and options expiration. This is important, but not urgent. The message is comforting.) The second is the Super Index. You can read more about it in this article, which is merely an introduction, and also my WTWA from three weeks ago. It reflects extensive research and testing, and is well worth monitoring. (The Super Index includes the ECRI approach). I am going to do a complete review of the work very soon. Meanwhile, I think it is important enough to watch every week.

The team working on recession forecasting and the SuperIndex continues to produce work that is absolutely first-rate. They are generating a suite of measures with differing time frames. For the investment world the key question is how much notice do we need? Here is a great answer:

Assume an investor is following a business cycle expansion buy-and-hold strategy, where the aim is to remain vested in the stock market for as long as possible before the onset of recession. Any defensive action longer than 4.8 months on average before a recession is going to be counterproductive for him or her. Think about this – in the 4.5 months since ECRI's recession call the stock market has rallied more than 22%. Is that counterproductive enough for you?

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.

The Week Ahead

This a light week for A-list economic data. It is a short week, influenced by the effect of last week's options expiration.

The initial claims series is the single most important report to watch right now, and we'll have an update on Thursday. There are revisions to Michigan confidence (Friday), and also some housing data, which might grab the focus.

Europe news is a wild card, but I see less concern and more emphasis on the US economy.

I monitor news and economic data every day in my diary at Wall Street All Stars (subscription required, but I have some membership discounts available for my readers).

Trading Time Frame

Our trading accounts have been 100% invested since December. Felix caught the current rally quite well, buying in on December 19th. There are now many solid sectors in the buy range. The overall ratings have improved, helping us to stay invested while many have been in denial for the entire rally. This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated. Felix has been more confident than I have been on the trading time frame. This illustrates the importance of watching objective indicators instead of headlines.

Investor Time Frame

Our Dynamic Asset Allocation model is still very conservative, but starting to change into equities. For several weeks I have joked that it is rather like the Nouriel Roubini of our methods. Dr. Roubini is now becoming more bullish. There is nothing wrong with this! There are many successful market strategies. The risk/reward balance is a personal matter.

To summarize, we have become much less conservative in all of our programs, There is still risk, but as our indicators become more positive, we can and should become more aggressive. For new accounts we are establishing immediate partial positions, using volatility to buy favored names and selling calls for those in the Enhanced Yield program. This program continues to work very well, meeting the objectives of conservative, yield-oriented investors. It follows our key precept:

Take what the market is giving you.

I have been repeating this each week, because it is by far the most important message. It is better than trying to time the market. You can buy great dividend stocks at reasonable prices with the chance to sell call options at inflated prices. If the stocks do nothing, you can still get almost 10% per year from dividends and call premiums.

This does not work for those selling long-dated calls. It requires some active management, selling calls with a month or two before expiration to capture the most rapid time decay.

The Final Word on Housing

I do not have a strong personal feeling on housing. I understand the need to work off the inventory of abandoned homes and to deal with foreclosures. This is the widely-cited shadow supply. I know also that there is shadow demand from new families and people unwillingly living with parents.

Housing demand is linked to perceived affordability and employment. Here are some sources that we should all consider:

Building Permits show increasing strength. This is a favorite indicator for me. Steven Hansen does a nice, in-depth look at the growth trend.
Affordability of housing requires looking at both down payments and monthly payments. Check out The Bonddad Blog for a good analysis of both.
Hard Data on Construction has improved, despite some builder confidence surveys (via Calculated Risk).

And finally, the conclusion from Calculated Risk, a source we all respect from the early and accurate analysis of the housing market decline. This conclusion is careful and nuanced, distinguishing a bottom in prices from a bottom in sales. Read the entire article, but here is the key takeaway:

And it now appears we can look for the bottom in prices. My guess is that nominal house prices, using the national repeat sales indexes and not seasonally adjusted, will bottom in March 2012.

I expect this to be an active topic of discussion this week and during the Spring. Any sign of life in housing would help the economy, and would provide some new sector and stock ideas.

February 19, 2012 in Housing Issues, Individual Investors, Interpreting Data, The Week Ahead | Permalink | Comments (4) | TrackBack (0)

September 22, 2010

How President Obama Can Help Housing -- Right Now!

The two biggest economic challenges are employment and housing. Furthermore, they are related. Weak employment increases foreclosures. Weak housing decreases aggregate demand and reduces net employment.

There is a cycle here -- an interaction between these two problems.

Obama Policies Miss the Target

Here at "A Dash" we try to remain objective about public poicy and the outcomes. Not everything works as expected. It is best not to be doctrinatire in your evaluation.

Briefly put, I am not a critic that will find error in anything and everything President Obama does -- just as I was not such a critic of President Bush. My concerns are specific and well-grounded.

Mistakes

As the President changes his economic team, here are some key points to keep in mind:

There have been too many voices. The original team lacked direction. Even if Obama is expert at identifying and drawing out viewpoints (as Warren Buffett maintains), that was not the task here. This was not a "single-issue" problem like the Cuban Missile Crisis. There are many dimensions.
It is not just a matter of political or economic philosophy. Even if a Keyensian stimulation was correct, that is a temporary solution.
There has been a disconnect between political types, trying to identify jobs saved or created on a website, and real economists. The most important job effects can only be identified through macro-economic modeling. This is not the way to win elections.
The transition delay -- the wrong people, questionable credentials, and a delay in everything that needed to be done.
Excessive emphasis on "macro" solutions.

No one won a Nobel Prize for analyzing the 2008 economic problems.

The people opining on this topic supported various theories that were not on point for the specific problems of the day. (I am not interested in a vaguely political/philosophical position about overall debt).

What Now?

The President has -- so far -- missed an opportunity for cheap, non-political policies that would have a big effect. Here are two key facts:

The role of government should be to facilitate the effective operation of private markets.

There is a huge current appetite for securities with a good yield and moderate risk.

What Could We Do? Restore Mortgage Securitization

Securitizing mortgages is a great idea that was poorly implemented. Investors are reaching for yield in the current low-rate environment. Meanwhile, the CDO market in mortgages has evaporated because of the crisis.

If we wish to move away from government as the backer of all mortgage debt-- and who doesn't -- it is time to restore this market.

The steps are simple:

Make sure that CDO's meet specific criteria -- no complexity of tranches. They should be plain vanilla. Risk is OK, if the product reflects this. The market will determine the right price.
Mortgage originators need some "skin in the game." This is the only way to keep the process honest.
Ratings agencies need to be strong and appropriate. This cannot be a "rubber stamp" process.
Ideally, the securities would be traded on a public exchange.

Providing a regulatory environment that would facilitate securitization would unleash the private market to connect borrowers and lenders. Unfortunately, none of the alphabet soup of temporary programs addresses these issues.

Meanwhile, should we be surprised at a decline in housing prices? There is no market for jumbo mortgages. The high end of the market has no liquidity. People cannot move from job to job, from city to city. The inability to borrow forces the market lower, generating more foreclosures.

Conclusion

Until we have a solid mortgage securitization process, we are stuck with government. That means there will be no real solution.

It is ironic that the solutions I suggest cost very little. There are no subsidies. It is a role for government -- providing the right environment for free markets to work -- that has widespread philosophical support.

Apparently the solution is too "micro" or too "technical" for the big thinkers. They are all engaged in a political debate, with an election at stake.

We have a moderate economic reobound that could be really exciting of we could address the housing problem effectively.

As I noted in my regular market preview, this week would see a focus on housing. I regard building permits as important.

September 22, 2010 in Current Affairs, Housing Issues, Markets | Permalink | Comments (3) | TrackBack (0)

March 09, 2010

Housing Supply and Demand

OK, here I go with another educational concept that has no immediate and actionable investment advice. I heard a couple of uninformed comments about housing. One was that the market needed to push prices down so that it would clear. This reflects ignorance. Markets clear at the current price.

The other was about shadow supply. Let's take a closer look.

Background

Forget the fact that nearly everyone is telling you something completely bogus. Accurate analysis requires several things:

A willingness to be led by data, not by pre-conceptions;
A strong analytical method;
Good data.

A Diversion

Sometimes in classes I would introduce a diversion -- an example that was easily understood and avoided the current bias. Let me take a swing at that here.

Oil producing countries are always pumping. If the current spot market demand for oil does not produce a high price, the producers do a calculation. How much would it cost to store oil, either on tanker ships or land-based facilities? Is the expectation of a future price high enough to justify the storage costs?

This is a calculation done daily in the sophisticated energy markets. And why don't the producers just stop producing? It is costly to do so. They have high fixed expenses. They make a calculation, at the margin, about what to produce.

This is a pretty simple conclusion. The oil producers have a supply of oil available at a price. The specific price depends upon many factors including their own cost of carry and production expense. These are all profitable and savvy market participants.

The result is a supply curve for oil -- a classic economic outcome. The higher the price, the more oil will be delivered. Is this a surprise for anyone? It is what you would expect from your intro Micro-economics class.

Shifting Gears

Let us now shift to an environment where the punditry holds suppliers in low esteem -- the housing market. I suggest that readers review the last paragraph substituting homeowners or home builders for the oil producers. I hope you see the trap.

We are trained to think of one group as smart and the other as dumb. In fact, both groups are operating in line with economic principles.

Shadow Supply ----- and Demand

This is an important subject. Many of the most popular talking heads are doing frequent pontificating without passing the chalk test -- they could not draw and analyze a supply and demand curve.

The pop economists do not understand distributions. For them, there is no supply curve. It is just a static inventory of homes that must be sold. In fact, the extreme part of the curve reflects those who would sell if prices were higher, but they choose to wait. This may be a very rational decision.

Similarly, pundits do not grasp the demand curve. The extremes of the demand curve reflects potential buyers, who would buy if the prices were lower. Instead, they choose to wait.

Nearly everyone talks about the shadow supply, so it has become the conventional wisdom. Meanwhile, what about shadow demand? Here is something that you have not heard anywhere else:

...the Boomer Woman's household is quickly turning into a remake of classic television shows from her childhood, shows like "Petticoat Junction" or "The Waltons," where several generations of one family live under one roof – usually out of economic necessity.

Families are getting crammed together and it creates a lot of stress. It is pent-up demand, but you never hear about it. These families are in the market for new homes -- ASAP. It will not play out until employment improves, and it will be gradual.

But guess what? The supply effects are also on a curve and will also be gradual.

The amateur and pop economists - -and that means nearly all of the most popular economic sites -- never discuss distributions for supply and demand. Anyone who discusses supply and demand without reference to a distribution and a shifting curve is not really analyzing.

This topic clearly requires more analysis of specific contentions. It may be good for a face-off.

March 09, 2010 in Housing Issues, Individual Investors, Interpreting Data, Reviewing Pundits | Permalink | Comments (8) | TrackBack (0)

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October 13, 2012

Weighing the Week Ahead: Will Q3 Earnings Disappoint?

September 02, 2012

Weighing the Week Ahead: What to do about Jobs?

August 18, 2012

Weighing the Week Ahead: A Lull Before the Storm?

June 30, 2012

Weighing the Week Ahead: Fireworks in the Forecast?

June 23, 2012

Weighing the Week Ahead: Time for some surprises?

April 21, 2012

Weighing the Week Ahead: Will the Fed Disappoint the Markets?

March 18, 2012

A Weighing the Week Ahead: Seeking Safety?

February 19, 2012

Weighing the Week Ahead: Time for a Turn in Housing?

September 22, 2010

How President Obama Can Help Housing -- Right Now!

March 09, 2010

Housing Supply and Demand

Individual Investors: Start Here!

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