An eclectic approach to better trading and investing. Finding market inefficiency. Discussing and applying the best ideas and methods from several disciplines.
There is a broad group of individual investors who are
completely out of stocks or significantly under-invested. Many were paralyzed by fear in the time after
2008. They have still not returned to investments in stocks.
This is a natural and normal reaction to risk. People fear losses more than they crave
gains. This natural human trait causes
most investors to do exactly the wrong thing at the wrong time!
There are multiple sources of fear, but the current theme is
that it is too late for this year. If you have not
been invested, you have missed the rally for three reasons:
The market has already made most of its gains
for the year, getting close to the targets of the most bullish of
prognosticators;
The move has been too far and too fast;
The time of seasonal weakness is upon us.
Let us focus on the first of these reasons – the price
target.
Why We Need Moving Targets
Here is an idea that can liberate investors:
Ignore calendar year market
forecasts!
If you are looking for an investment edge, here it is. Most people analyze portfolios based upon the
calendar. World events march to a
different drummer!
This year is a great example. The annual forecasts were done at a point when
everyone was worried about the fiscal cliff, a downgrade of US debt, an
imminent recession, and a hard landing for China. When this did not happen, (an eleventh hour
result that I predicted), the market rallied about 6%.
Suppose that you missed that rally. Should you pretend that the facts did not
change? Should you remain anchored to
your December, 2012 forecast?
Or should you adjust your thinking to reflect new evidence? Just suppose that the fiscal cliff issues had
been resolved in November, 2012. We
would have started 2013 from a higher level.
My Method
I have a personal method that has worked well for more than
a decade: I use a rolling twelve-month
forecast. I do this for individual
stocks and also for the market. I refuse
to be chained to the calendar.
When the underlying data change, so does my price target. The calendar does not matter. My thinking is flexible, taking what the market is offering.
Some Agreement from The Street
I am surprised and pleased to see that some top analysts are
recognizing the need for more frequent reviews of their price targets. Instead of going with the knee-jerk reaction,
please give some careful attention to these analysts, who see S&P targets as high as 1760 for this year:
There are others in the club.
As background, Bespoke noted more than a month ago that the rally was approaching the Street targets - check the chart and commentary.
These are all analysts who recognize that circumstances have changed since the time of their original forecasts. This is in sharp contrast to what happened at the end of last year, when analysts stubbornly held to foolish forecasts.
Investment Implications
This is one of the easiest ways for the average investor to get an advantage over the big-time sell-side forecasts. Most data sources provide earnings for a calendar year. Here at "A Dash" I try to do better by finding the best sources.
Isn't it obvious that a rolling one-year forecast is better than locking into the calendar?
If you had the data, you would do it. I often provide such information. I get it from Brian Gilmartin, and occasionally Ed Yardeni.
I explain to all of my new investors that even good years will include a correction of 15% or so, regardless of the fundamentals. I cannot time these and neither can anyone else. It just comes with the territory. Develop and stick to your forecast.
Looking at the long-term fundamentals is the key to long-term success. There are many stocks trading at significant discounts based upon current earnings. These can often be found via Chuck Carnevale's first rate web site.
Some current favorites from assorted sectors are AFL, CAT, and JPM.
I will try to elaborate further on this theme, but this installment is timely.
Why does this happen whenever I try to take a few days off? The market for dubious predictions has geared up in earnest!
While on vacation I was watching the market (but without my customary TIVO), events developed exactly as I predicted. I warned about signal and noise, the challenge to traders, and the opportunity for long-term investors.
I have also been reading Nate Silver's book, The Signal and the Noise, which includes a lot of wisdom on these topics. I plan a full review when I finish.
One of Silver's points concerns predictions without any confidence interval. Many themes will be familiar to readers of "A Dash" since I highlight pundits who claim expertise outside of their "happy zone." Let us highlight the three worst items from the past week.
The fiction -- the ECRI claims that we are now in a recession. This is ECRI 4.0 after their 2011 forecast failed, their revised 2012 forecast failed, and their complaint about seasonal adjustments being wrong has not proven out. They are now playing out the last straw, that they are the only ones who can forecast recessions in advance and that no one else knows until after it is over. This will obviously require a deeper look. Let me cite the most obvious incorrect statement in their claims: The business cycle has peaked and they are the only ones who know this.
The reality. No one knows whether the current period will eventually be defined as a recession. A recession requires a significant decline (which you do not know until you have seen it). At that point the NBER goes back to the last peak. The ECRI presentation last week "assumed facts not in evidence." They are ignoring the reduction in business spending before the election and the fiscal cliff. They are exploiting the Super storm Sandy effects. We can expect them to pound the drum even more during the next month, since the weak patch will take a couple of months to sort out.
I have a personal sadness about this, since I like and admire the ECRI principals. I am going to write another piece about how and why their methods failed. I wish that they had just been willing to accept the changing evidence -- and maybe open the kimono a little bit.
The fiction --- the decline to zero growth. GMO's Jeremy Grantham opines that the US economy is on a zero growth path until 2050. He focuses on the two best drivers of growth -- population and productivity. In this CNBC segment Maria Baritromo breathlessly praises Grantham:
"...He gets paid to make predictions, steve. that's what he's doing. by the way, his former predictions have been right. let's give him that."
The reality. No one knows what will happen in 2050. Grantham has ignored a decline in immigration (something that has helped US GDP in the past) to support his perma-bear position. Pretending to this kind of knowledge gets headlines, but should be a warning signal to investors. The media commentary points out that he manages a gazillion dollars or so. Maybe a few of those investors should look to managers who are more grounded in facts.
And by the way, maybe Maria should cite Granthams track record -- 47% -- before claiming that he has made so many great calls. Anyone who takes this silly prediction seriously should look back forty years for a comparison.
The fiction. The latest new and greatest recession indicator. This is from Lance Roberts (who without apology highlighted the bogus 100% recession indicator). He is now back with a new entry, endorsed by John Hussman. Roberts takes some existing economic forecasting indicators that do not initially give the result he hopes for. He then does some arithmetic and creates something that has a lame correlation to past recessions. Hussman (who does similar things) embraces this approach.
The Reality. The St. Louis Fed creates about 60,000 data series. If you do some math transformations as Roberts did, you can turn this into a million or so possibilities. If you then set a "trigger" at an arbitrary level based upon a handful of past cases (the way Hussman does) you can multiply this into the hundreds of millions range.
It is bad research, bad methodology, and a seriously misleading result. It is impossible to prove, since the bad guys used all of the data. There is nothing left to prove them wrong.
Conclusion
So much bogus commentary, and so little time. Can't a guy take a few days off?
I will follow up on all of these themes. Here are the main ideas:
Recession
The ECRI errors will require a more careful review -- it is on my agenda. Meanwhile you can get the basic concept of their mistake by reviewing my recession forecasting page.
Fiscal Cliff
This theme continues with silly trading in the absence of information.
Listen up!! We have no new information since the election.
We will not know anything new for a few weeks. Trade at your peril.
Opportunity
It almost seems too obvious. So many have much at stake in scaring investors. They have clearly won the battle, with aggressive money flowing into anything with a high yield and conservative money going to farmland and ammunition. My conversations with investors show that many are scared witless (TM OldProf).
Since the big rewards go to the contrarian investor, there are some great opportunities.
I like CAT as the proxy stock for an economic rebound, although it is (incorrectly) China-centric.
I also like some health care insurers and defense stocks -- UNH and LMT as examples -- as winners in the fiscal cliff compromise.
AFL is a good play if there is no disaster in Europe.
These are complex questions, so I plan to write more on each issue.
Consumers of investment information are getting short shrift.
I see three problems:
Producers of the big news shows are looking for the dramatic;
Journalists (with a few exceptions) have lost the ability to ask the important questions -- the ones that would help investors;
All media sources have been unduly influenced by email and tweets. These come overwhelmingly from the trading community -- and these sources have dogs in this hunt.
A Deeper Look
Here is the problem. There is a standard group of experts who seem to have the right connections. This might include any of the following:
Being famous for being famous. I am reminded of Paul Lynde, famous for being on Hollywood Squares.
At least you knew you were getting entertainment. I am open to suggestions for comparisons, but how about Marc Faber? He is widely known for his doomster reputation, but what has he done for us lately? He makes a regular appearance on CNBC where he gets respectful, softball interrogation.
Suggested questions? What is the time frame for your current prediction of a 100% change of global collapse? When did this prediction start? Is it true that there is no way to avoid this disaster?
Working for a big firm. It is interesting that big-time media love to criticize the big firm's analysts, but also feature them. This week there is a lot of buzz because one firm thinks that there is a big chance that the "fiscal cliff" will create a market collapse. The firm notes the discrepancy between their outlook and their clients. The lead member of the team is an undergrad math major with a background in real estate. No one points this out. People seem to think that since he was hired to be the major portfolio guy at a big firm he must know what he is doing. The same people would join in criticizing a "whale" trader or an analyst.
Suggested questions: Since you are basing a big market call on a prediction about the American political process, do you have any political scientists on the team? Did you consult anyone with a real track record on this subject?
Ability to regurgitate the latest Wall Street truthiness. My favorite current example is the intonation --- "Earnings estimates are too high. They must move lower." This has been repeated so often that I wonder if anyone is really analyzing the data. I report the change in earnings estimates nearly every week. It is not difficult to track this, and a smart consumer of information can find the best sources.
Suggested questions: How much do you think that earnings estimates should be reduced? What would the P/E ratio be at that level? Do you have a personal track record in making earnings estimates, or are you a critic of the work of others? If you are analyzing others, what is your record in finding the best sources?
Making dramatic calls. We all know that excitement sells and fear sells even better. Current examples include two distinct groups
Those predicting a recession based on back-fitting hundreds of variables with a sliding scale on each. This creates hundreds of degrees of freedom and invalidates the entire process. I understand that only 1% of readers will grasp this, and that is the point. Many are mesmerized by credentials and unable to evaluate the analysis. Anyone can come up with a perfect "Auntie Mame" system after the fact. If it didn't work, you would not hear about it.
Those predicting hyperinflation, generally based upon the loose assertion that the Fed is "printing money." Since this fits the preconceptions of the audience, it is an easy sale.
If someone is making a bold call, isn't it reasonable to ask a few basic questions? When did you first make this prediction? Has it ever changed? Do you have any real-time record of success? Does it include more than one instance? (This is crucial since many pundits hang their hats on a single big call. Readers might compare the current trader reaction to, say, Elaine Garzarelli and Abby Joseph Cohen, who are reviled, to the current crop of doomsters, who are celebrated).
Something else -- a mystery component. There is one frequent guest on CNBC is has been wrong forever, who has been completely inaccurate on the facts of money supply, who insults and interrupts everyone, who has shifted to multiple firms in a short time ---- and yet --- is a frequent guest on CNBC. They must love this approach, but consumers should tune out his story.
Conclusion
I understand that this post is mostly critical of bearish analysts and the lightweight questions asked of them. Obviously, I would also like to see tough questions to those who are bullish -- especially the perma-bull types.
As someone who offers a wide variety of investment programs -- not just long stocks -- I carefully study informational bias. I am open to any approach, and I profit only if my clients do. I highlight exaggerated fear because that is the current bias.
Everyone agrees that the economic recovery has been disappointing. There is no consensus on the cause. Nearly everyone has missed the most crucial element: The crisis of confidence.
Confidence is essential to economic success, as we have known for more than a century. Listen to this brief sound clip, instantly recognizable to many.
The background story is not so well-known. The TeachingHistory site provides an excellent description of the drafts of FDR's first Inaugural Address, and the changes involved. The most memorable line was actually taken from discussions in the business community, as noted here:
"The phrase “The only thing to fear is fear” and its variants, therefore,
were demonstrably “out there” in circulation within the business
community during the first few decades of the 20th century. William
Safire makes the point that it does not really matter where the phrase
came from because it was FDR that used it during his speech to inspire
the nation and it was he, therefore, who transmuted the linguistic coin
into rhetorical gold."
[How I miss William Safire!]
When confidence is lacking, we get less (not all or nothing, but less) of the following:
Employers are less willing to expand -- new plants, new workers;
Potential entrepreneurs are less willing to act -- new businesses, new jobs;
Young families are less willing to buy new homes;
Anyone worried about employment is less willing to make a major purchase;
Banks are more reluctant to lend;
And many other similar effects.
Without the ingredient of confidence, the economic engine is missing an element. It is time to retire the "pushing on a string analogy" which has outlived its usefulness. I suggest that we call this the "Confidence Gap."
We have all of the elements for the economic engine -- deferred demand, strong balance sheets, and potential profits for all. There is one thing missing. I think of it as the "spark plug gap" being a little too wide, but that is because my education includes the ignition coup of a young sailor with his cap at a jaunty angle.
Who is responsible for the "confidence gap?"
There are plenty of candidates, especially after last year's debt ceiling fiasco.
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. One source I
especially like is the weekly post from the WSJ's Market Beat blog.
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 very good, even better than the market result.
Rail traffic is better, especially measured by intermodal traffic. See Todd Sullivan's take and his helpful chart.
Sentiment (a contrarian indicator) is below the bullish average of the recent market rise (via Bespoke).
Housing had a good initial reaction to the QE3 announcement (via Dr. Ed).
Home sales data were encouraging (via Calculated Risk) where you can see a comprehensive look at sales and building permits as well as this revealing look at the improving inventory situation:
The Bad
There was plenty of bad news last week.
Flash PMI indicators from Europe were weak (via multiple sources). I noted this source in last week's preview. There is a thirst for data because we are so interested in news from Europe and China. The same pundits who express skepticism about "surveys" rush to embrace this source. I am watching, but with some caution. I like to see a longer track record.
Initial jobless claims remained in the danger zone. Seasonal factors might still be in play, but I continue to regard this as bad news. Here is the long-term perspective in the chart from Doug Short:
Greece is headed back to the front burner for market worries. Our key source on that topic, The New Athenian, notes both the demanding requirements and the slow progress toward meeting Troika requirements. The Greek dilemma remains on the agenda for a Euro solution.
Gasoline prices rise again -- up more than four cents. Check out this and other "mixed" high frequency indicators from Bonddad.
Leading Economic Indicators had a slight decline. Doug Short puts this in historical perspective:
The Ugly
Denard -- not at his best. I am expecting a rebound from my favorite college player, but this is a great illustration of dispassionate investing versus emotion! I am cheering for Michigan -- as usual -- but not investing:)
Meanwhile, readers are invited to submit ugly news that I should have noted!
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
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.
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 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 articledescribes
the complete history, the critics, and how it has played out. The post
highlights the most important economic indicators used in
identifying recessions, showing that none have rolled over. Doug
updates the recession debate every week and includes a great chart of
the "big four" indicators used by the NBER in recession dating.
This has become a mandatory weekly read for those who are still worried about a new recession.
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 after a
brief stint at "neutral." These are one-month forecasts for the poll,
but Felix has a
three-week horizon. The ratings have moved a little higher, and the
confidence has improved from last week. It has been a close call over
the last few weeks.
[For more on the penalty box see this article.
For more on the system
ratings, you can write to etf at newarc
dot com for our free report package or to
be added to the (free) weekly ETF
email list. You can also write
personally to me with questions or
comments, and I'll do my best to answer.]
The Week Ahead
There is a busier calendar for data this week. As noted above, my grading of the reports relates to what I see as important.
The "A List" includes the following:
Consumer Confidence (Conf Board) (T) as an important confirming concurrent indicator
Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
The "B List" includes several reports:
Michigan Sentiment (F) is as important as the Conference Board, but we already have the preliminary read for the month.
Chicago PMI -- once again more significant because of the weekend before the national PMI. This is the most reliable of the regional indicators.
Personal income and spending for August (F). Other indicators may seem fresher, but this is important confirmation and could move the market.
Durable goods (TH) has the same significance and interpretation as Personal Income.
There will be assorted speeches by central bankers, but the key discussion will be about Spain. The market wants Spain to agree to a bit more austerity and request an official bailout. This news will be greeted as bullish, sending Spanish yields lower, the Euro higher, and US stocks higher as well.
This may seem counter-intuitive to some, but that will be the take. Watch for it.
Trading Time Frame
Felix has moved back into a marginally bullish posture over the last two weeks, but it has been a close call. In practice, the official forecast has mattered little to our trading positions. 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. The ratings have been getting a little stronger, so we maintain the profitable trades.
Felix does not try to call tops and bottoms, but instead keeps us on the
right side of major moves, either up or down.
Investor Time Frame
Many long-term investors have simply lost touch with reality. Here is an astounding research finding:
"One surprising finding shows that investors are likely so consumed
by the negative economic news, including high unemployment and the weak
housing market, that they haven't even noticed the strength of the stock
market.
For example, when 1,000 investors were asked whether
they thought the S&P was up or down during each of the past three
years, 66% thought it was down in 2009, 48% thought it was down in 2010,
and 53% thought it was down last year.
In fact, the S&P gained 26.5% in 2009, 15.1% in 2010, and 2.1% last year."
Understanding the attractive fundamental conditions is the first step for the long-term investor, but it does not mean that you should be going "all in."
How much risk should you take?
The right answer is different for everyone, but too many people choose
"zero." These investors do not follow the Buffett advice of buying when
others are fearful. Then, when the market rallies, they are afraid
that they are "too late." I wrote a new article, Stock Prices and the Fundamentals: Don't be Fooled,
showing how to avoid this trap. The answer is not going "all in" since
most of us have to pay more attention to short-term risk than does Mr.
Buffett!
Should you worry about the "fiscal cliff?" The basic answer is "not yet." I explain why in two articles. The first reveals my one-word solution. The second offers my current expectations, and how I am investing for the long-term program.
If you have been following our regular advice, you have done the following:
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; and
Added some octane with a reasonable allocation of good stocks.
There is nothing more satisfying than getting yield and call premiums, even if stocks move sideways.
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 and suggestions welcome!)
Final Thoughts on Confidence
There are some glimmers of improvement. The latest WSJ/NBC poll includes these two results (via Washington Post, where you can see their other six key takeaways):
A burst of “right direction” optimism: Nearly four in
10 people said that the country is “headed in the right direction” — the
highest that number has been in NBC-WSJ polling since January 2009. By
way of comparison, in NBC-WSJ polling in August, July and June the
“right direction” number never rose above 32 percent. Important piece of
context: A majority of people — 55 percent — still say that things are
off on the “wrong track”.
Economy improving?: In a bounce similar to the “right
direction” improvement noted above, 42 percent of people now believe the
economy will get better over the next year, an improvement from the 36
percent who said the same just a month ago. That burst of optimism comes
not from those who had previously been pessimistic — 18 percent in both
the August and September NBC-WSJ poll said the economy would get worse —
but rather from movement among those who had previously predicted the
status quo (38 percent in August) and now feel more optimistic (32
percent in September).
This is only a start, but most readers probably are not seeing these indicators in their regular reading.
Tracking confidence measures of all sorts is important for investors. This is how we will discover that prospects are improving --- or not!
This week's upcoming data will provide updated information on consumer sentiment. We will see more on the candidates and general economic sentiment as well.
The Payoff -- If Confidence Returns to Normal
Some astute observers see plenty of upside. JP Morgan's Thomas Lee notes that if the S&P earnings yield merely equaled the high yield bond (a frequent past metric), the S&P 500 would be at 1600. Check out the entire article to see what else might happen before election day.
It is going to take heightened confidence before we see this, but it certainly could happen.
As stock prices made new highs this week, a frequent media theme was that this was happening --- drum roll!!!! ---- in spite of the fundamentals.
If you listened to the accompanying discussion, you eventually learned what was meant by "fundamentals." For many observers it is some kind of unquantifiable headline risk. As long as there is something to worry about, something to call a "headwind," then this viewpoint means that "the fundamentals are bad." The parade of pundits warns that you should make sure that all of these risks have been resolved before investing. Don't hold your breath waiting for that!
The big reason that traders are missing the rally is that they mis-define "fundamentals."
Comparing to the 2008 Highs
I lost count of the stories saying that we were back to the 2008 highs. Danger! The idea seems to be that we all remember what happened then, so watch out! We also have triple tops and the like. (Whatever happened to the Death Cross and the Hindenberg Omen?)
So I did some checking.
May of 2008. Forward earnings on the S&P 500 then were 93.77, the ten-year yield was 3.9% and the odds of a recession -- according to the best method -- were nearly 100%
Now. Forward earnings are 108, the ten-year yield is 1.59% and the recession odds for the next year are below 10%.
People talk about headlines and sling around phrases like Draghi put, printing money, etc., instead of analyzing data. The world is a much better place for investing than it was in 2008.
(This is not a political blog, and the comparison to four years ago relates to the market, not the election cycle. I am well aware that the mileage has varied for many people. Most folks do not have significant stock holdings. At "A Dash" we aim to engage in successful investing no matter who is in power).
The Failure of Static Analysis
The bogus fundamentals of the "headwinds pundits" never change. They can always complain that there is too much debt and too much government.
They are basically in denial about the power of government and central banks. Put aside your political viewpoint. Go ahead and cheer when Rick Santelli tells you that this is all a "sugar high" but put emotions aside when investing.
Meanwhile, Rick is not a candidate to get on the FOMC -- nor is Ron Paul. Furthermore, if Romney is elected we will see someone who shares the Bernanke philosophy. But that is a subject for another day.
Your assessment of the fundamentals should change with events, represented by actual data!
If you do not have your head in the sand, you are watching the events in Europe. On Thursday, the Spanish 10-year yield is down to 6.02%, down 59 bps. This is important for the ability to refinance debt, and much lower than the touted "danger zone" of 7%. On Friday, Italian 10-year yield now 5.02%. Spain at 5.57%, down another 39 bps. This is not
the point of the curve where the ECB proposes to buy.
This is market data, confirming what I have been telling investors for nearly a year with the decline in the St. Louis Financial Stress Index.
If you are following the data, you know that the world is a better place for investors now than it was a week ago. It is much better than it was four years ago.
The fear premium in the market is still very high. I know that many investors (mistakenly) think that it is too late to buy stocks since we are at the old highs.
This article is for you!
Last year I explained how to use data to evaluate fundamentals. Here is a brief quote covering one topic, but I invite you to read the entire article, where I cover valuation, risk, and potential:
I use the one year forward earnings from the "bottoms up" estimate
from Thomson/Reuters. Many critics take the inconsistent position that
forward earnings are too optimistic, but explain the typical 70% beat
rate by saying that estimates are guided down. I have written about this at length and challenged the skeptics.
I maintain that there is a point where forward estimates by bottoms-up
analysts are quite useful -- the best we can do. That point is
approximately one year ahead. I continue to invite any loyalist for
another method -- particularly those espoused by Hussman or Shiller --
to show that they can predict earnings one year in advance with greater
precision.
With this in mind, the "Jackson Hole" forward earnings yield was
8.31% and it has declined to 7.74% now. When compared to the ten-year
yield (interest rates in the table) the risk premium was a huge 5.75%
last Fall and is still 4.61%. On a long-term basis this is a juicy
premium unless risk is huge.
Conclusion
All of the metrics are better now than they were at the prior market top. This is why stock prices increase over time --- the fundamentals, defined correctly, get better.
If I had to pick one stock right now that reflects the changes, it would be Aflac (AFL). The earnings and dividends are great. The valuation is low because of excessive fear about Europe, where the company has invested insurance premiums. Cyclical stocks like CAT are great and I still like tech stocks like ORCL. There are many names consistent with this theme.
These stocks have bounced from the lows, but you are not "chasing." The valuation is still solid and I buy them for new clients on day one.
In the short-term world of trading, your job is to anticipate the short-term behavior of others.
In the world of investing, your job is to take advantage of the short-term behavior of others.
Markets render a short-term verdict, but only professors believe them to be efficient. Warren Buffett famously notes (see here for more wisdom):
“I’d be a bum on the street with a tin cup if the markets were always efficient.” Fortune April 3, 1995
“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.” Berkshire Hathaway 2004 Chairman’s Letter
This is great advice, but difficult for most to follow. How can we tell when the market is inefficient and fearful. We need evidence! Should we bail out of the market? Should we buy puts (even at high prices) to protect our risk? Let us turn to another expert-- Perry Mason (actual historical ad -- and many others -- available here).
Let us take the advice of these two great iconic figures, seeking edge through evidence.
Since the recent European elections there has been a dramatic change in risk appetite. Ed Yardeni sees this as a switch for risk on/risk off.
"The big switch was flipped to the off position following the May 6 French and Greek elections, which could upend all the bailout deal and fiscal pacts worked out by European leaders over the past two years. Such an outcome could push Europe deeper into a recession and weaken global economic activity. In other words, Risk On tends to be associated with widespread confidence in the outlook for global economic growth, while Risk Off indicates widespread fears that the global economy will sputter."
Investors need evidence! Is the pessimistic outlook warranted? This week will provide more data.
As usual, I will offer some ideas in the conclusion, but 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 list of upcoming events. In contrast, 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.
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 US economic data last week was mixed, but had some high spots.
Housing and Car Sales Lead. The Bonddad Blog takes a page from UCLA Prof Ed Leamer to reach the following conclusion and chart:
Put simply, as an economic expansion ages, housing is the first sector to weaken, followed by cars. If they are strengthening rather than weakening, a recession is not near. And to be blunt, both sectors are indeed strengthening.
Let's look at this three ways. First here are the raw numbers of housing permits (left scale) and vehicle sales (right scale), measured quarterly to limit some of the noise. Both peaked well before any recession started, even in the case of the brief expansion in the middle of the 1980-81 "double dip":
Signs of GOP compromise. Fewer GOP candidates are signing the Grover Norquist "pledge." I cite this not from a partisan perspective, but as one who seeks solutions and compromise. Concessions by either party are good. (More to come on the "fiscal cliff" issue.)
Michigan Consumer Sentiment hit a four-year high. While this was helped by lower gas prices, it also reflected perceptions of better job prospects. Check out the chart from Doug Short -- still not at peaks, but also not confirming the recession scare.
Zillow data suggests that home prices are moving higher (via Calculated Risk).
New home sales strengthen. Calculated Risk has been authoritative on this subject for years, so I am watching the analysis and forecast (a long and gradual recovery) with great interest. Here is Bill's comment on the recent data:
"Clearly new home sales have bottomed. Although sales are still historically very weak, sales are up 25% from the low, and up about 15% from the May 2010 through September 2011 average."
The Bad
There was plenty of bad news on the economic data front. Here are the most important items.
Downticks in "flash" PMI reports. These are getting a big play for those with a short time horizon. The question is whether the captured data is really accurate. The initial forecast for the US PMI was released by Markit Economics, predicting a dip. There were also negative reports on various European countries. This is an interesting new data source for the US, worth watching with interest.
Durable goods sales were weaker. Steven Hansen has a thoughtful analysis, looking more deeply into the headline data.
The informal European Summit disappointed. While the Eurobond concept was floated and stronger deposit insurance mentioned, there was no solid outcome. The market wants immediate answers, and the European leaders have a different time frame.
Spanish bank problems threaten escalation and contagion. Spain has stepped in to assist with bad housing loans at the fourth-largest bank. While this is a pro-active move, investors immediately raised questions about the status of other banks. How much more help will be needed?
The Ugly
The "fiscal cliff" grabs the ugly award for this week. The authoritative Congressional Budget Office (CBO) reported on what would happen in the absence of any policy changes. Assorted tax cuts and stimulus programs will expire. This is headline-grabbing stuff, especially for those who have not been paying any attention.
Hardly anyone expects even a fraction of this to take place, but it makes for good headlines. The marginal effect is clearly negative as the average investor acts in a way that he/she believes to be smart and well-informed.
It is wall-to-wall crisis coverage. I plan to write more extensively on this topic.
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
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 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 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.
This week's big news on the recession forecasting front this week came from New Deal Democrat writing at The Bonddad Blog. He notes that the ECRI has retreated from a robust method with many leading indicators, seasonally adjusted, to a single reed. NDD snips that reed, showing why the year-over-year real income indicator is misleading.
Meanwhile, there are many others who have developed recession forecasting methods that have matched or beaten the ECRI, while providing transparency for consumers. These are the methods that I have been highlighting for many months.
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 "bearish" although we do not (yet) have any short positions. Felix respects the market action, and the last three weeks have been convincing.
[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
Sometimes the quirks of the calendar mean that we get a lot of important data in a short time frame. That is the story this week.
Friday is the big day since it includes the employment situation report along with the ISM manufacturing data (a good input for estimating the jobs report.) We will also get personal income and construction spending.
Thursday is the big tee-up for Friday. The Chicago PMI is the best guess about the ISM index. The ADP report is the best guess for the non-farm payroll number. We also get the (backward looking) adjusted Q112 GDP data and initial jobless claims (not part of the Friday reporting periods, but more recent and relevant).
Tuesday and Wednesday will provide housing price data from Case Shiller (a bit old) and Conference Board consumer confidence.
While there are no big decisions scheduled from Europe, we know that there can be headlines -- plus or minus.
With all of this in mind, the US employment story is the feature for the week.
Trading Time Frame
We have been partially invested in trading accounts, in a bearish position with 1/3 of our position profitably in bond ETFs. It reflected our "bearish" posture, and I would not be surprised to see a "buy" recommendation for an inverse ETF next week. Felix does not try to call market tops and bottoms, but respects trends in the three-week range.
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. You can contrast this with the many pundits who claim miracles of market timing.
The single most difficult thing for me to explain is that investors should often embrace opportunity just as traders are trying to do some fancy footwork. Investors should not be trying to guess the next market move. Instead, take what the market is giving you. You should not be a "buy and hold" investor, but instead engage in active management. Think about risk control rather than market timing.
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 Economic Evidence
Factual evidence consists of actual economic data and - -more importantly -- reported corporate earnings. So far, the factual data has been strong.
Speculation from many sources includes a European collapse and a US recession, leading to lower earnings.
Does the current market reflect the speculation or the facts? Here are some interesting perspectives:
Brian Gilmartin, a favorite of Real Money fans, has a new blog. Fundamentalis features corporate-specific earnings news as well as a macro take. Brian is off to a great start, and we will all enjoy reading his work. On the current earnings front he notes, "...(N)o matter how earnings act, the market p/e continues to compress over the last 12 years. In fact, despite 20% – 30% growth off the 2009 bottom, the S&P 500 hasn't traded much over 15(x) earnings since then. Even during the 2003 – 2007 rally, the S&P 500 multiple stayed roughly even with earnings growth at about 15(x) earnings."
Scott Grannis agrees, suggesting that the market is pricing in plenty of bad news.
"As a reminder, the chart above shows the trailing PE ratio of the S&P 500. At 13.4 today, it is approximately equal to what it was at the end of 2008, when the market fully expected a multi-year global recession/depression and years of deflation."
I did not set out to write a trilogy about Europe, but the market is telling us that nothing else matters right now.
My long-standing position is that Europe is engaged in a normal democratic political process with a very large number of contending parties. In such matters it is difficult to predict the exact outcome beyond saying that no one will be completely happy.
My approach is pretty modest in terms of forecasts. I do not know what the exact outcome will be. My current guess includes the following:
The eventual outcome will include a bit less austerity because of recent election results;
European leaders will manage to avoid the very worst outcomes; and
The nature of the political process leads to eleventh-hour solutions, permitting everyone to fear the worst as long as possible.
Nearly everyone else, regardless of credentials, claims a better crystal ball than mine. There is actually a wide range of possible outcomes worthy of review.
Possible Endgame for Europe
Let me rank these from worst to best.
Doomsday! This is the story getting the buzz. There will be a bank run in Greece based upon fear of leaving the EuroZone. This will rapidly spread to other countries. Advocates of this concept point to the sequential attack on banks in 2008 to prove their point.
Nearly every media source has now highlighted this graphic possibility, so it is already familiar to everyone. CNBC now promises to show lines at Greek ATM machines, in the same way they helpfully showed us oil spilling into the Gulf during the time of the BP oil spill.
The slow-moving train wreck. This is the analysis from Nouriel Roubini.
"...there are only four ways to achieve such real depreciation:
First, a sharp weakening of the euro. But this is unlikely as Germany is strong, the U.S. economy is weak and running twin deficits and the ECB is not aggressively easing monetary policy;
Second, a rapid reduction in unit labor costs through structural reforms that increase productivity growth in excess of wages. But this is just as unlikely: It took 10 years for Germany to restore its competitiveness this way; and Greece cannot stay in a depression for a decade, until reforms start to have a real impact;
Third, a rapid deflation in prices and wages, known as an “internal devaluation.” But this would lead to five years of ever-deepening depression, while making public debts more unsustainable as the fall in prices would increase the real value of such debts (the balance-sheet effect of debt deflation);
Fourth, if the first three options are impossible, the only path left for Greece is an EZ exit: A return to a national currency and a sharp depreciation would quickly restore competitiveness, improve the trade balance and rejuvenate economic growth.
The full analysis from Dr. Roubini is available at his website ( subscription required, and where I am a long-time contributor).
The Roubini analysis is very pessimistic for the EuroZone. My only objection is that it is a pure economic approach with little allowance for changes by the leadership. Meanwhile, I find it interesting that Dr. Roubini sees the process as playing out over time. My guess is that most would be astounded to discover that he is personally 70% invested in stocks with a 50-50 split between global and the US. You can see a full CNBC interview here.
The PBS Newshour balanced viewpoint. I understand that some may disagree about balance, but PBS does try to get a strong representative for differing viewpoints. They had a great segment featuring an Athens source I have featured, a prof from the Kennedy School at Harvard, and Fred Bergsten from the Peterson Institute. Here is Bergsten's comment:
"My bet is that they would get back with the program. And despite the abhorrence of the program by the Greek electorate, understandably, their desire to avoid being kicked out of the euro would be even greater. So, it's going to be messy, but I think the outcome, whether driven by bank runs or by a new election, is going to be to force them back into the fold, at least to an important degree, enough that the Europeans can keep lending them money.
Everybody saves face. A growth element will be added to the package. There will be a little modification in the austerity requirements. But it will be basically back to the program as has existed for the last couple years."
Here is the entire video from PBS. I urge readers to watch it -- a nice change of pace from their regular diet of financial news.
The Marshall Plan for Europe. London-based journalist Matthew Lynn offers an intriguing alternative. Germany, recognizing self-interest, decides that the EuroZone breakup is not such a good idea.
Investment Conclusion
Getting great investment returns means going against the flow. If you just followed the market, you would be average. If you try to guess the market, you are usually blundering at the major turning points.
Most investors are looking only at the worst case of the possibilities listed above. Meanwhile, those who focus on fundamentals will be right on Europe, right on the economy, right on earnings, and (eventually) right on stock prices.
Prior pieces in the trilogy include the following:
As part of my work I speak with smart people from differing backgrounds:
Individual investors -- clients and potential clients;
Business leaders -- colleagues on corporate boards;
Leading economists and journalists -- both groups well-represented at the recent Kauffman Conference;
Colleagues in the blogging world.
There is an interesting pattern. Most of them feel more confident about their personal circumstances, but they are worried about everything else. When it comes to the stock market, the fear is palpable.
Even the pros are struggling to get a handle on this market. Readers know that I love Art Cashin. A good friend gave me an autographed copy of his book. I have been reading his daily wisdom since I started in the business in 1987. He really does have the pulse of the NYSE floor. When Art says that the normal yardsticks are not working, we should all pay attention.
If Art and the NYSE traders find the market confusing, the rest of us are in good company!
Finding Clarity
There are two perspectives -- trading and investing -- with differing time frames. I explained this here, and I encourage everyone to read it as background.
The traders must deal with all of the issues Art Cashin raises. Our Felix model finds it all confusing, and has sent all of our 28 trading sectors to the penalty box. Felix realizes that traders should not press when confidence is low.
The investor perspective is more interesting. My email and comments suggest that the most helpful work I have done relates to explaining something called "the wall of worry."
When I first saw this term, I confess that it seemed rather silly. As an academic who began an investment career with some basic confidence in the efficient market hypothesis, I expected fresh information to be quickly reflected in market prices.
I soon learned that this was not true. Warren Buffett (one of my heroes, and we all wish him the best) put it well when he said, "I’d be a bum on the street with a tin cup if the markets were always efficient.”
This meant that an astute investor could beat the market, but it required better methods.
The single biggest source of investor profit relates to evaluating what many call "market fundamentals" and others call "headwinds."
A List of Worries
Here is a list of worries for your consideration:
ETF liquidation doomsday scenario
Flash crash -- and overall worries about market manipulation
Bush-era tax cut expiration
Collapse of the euro and/or European Union
The Hindenburg Omen
Increase in US budget deficits
Ominous head-and-shoulders pattern in market averages
Dow 5000
Dow 2000
Dow 1000
The collapse of the US consumer
The double-dip recession
Sell in May
Sell in October
Sell, Mortimer, Sell (OK, I sneaked that one in for those who know).
The BP spill
Fear of Obama
Obamacare
Weakness in the dollar
Strength in the dollar
Weakness in China's economy
Strength in China, leading to higher rates
Korea
Iran
Initial claims spiking to over 500K
Initial claims falling, but results skewed by seasonality
Shadow housing inventory
Foreclosure robo signing
Overstated and exaggerated corporate earnings
Fed blunders -- QE II
High frequency trading
Worldwide collapse and deflation
Worldwide hyperinflation
If some of these seem a bit outdated, you are reading carefully. The list is from December, 2010.
It is a good look back on the history of worries. Readers should note that worries and headwinds are not quantified. Anyone can deal in words and anecdotes. It requires some expertise to include data. Those of us who have been data-driven have beaten the anecdotal crew by a wide margin.
Current Worries
Let us turn from the old list to the most important issues raised by current market skeptics. Dick Green at Briefing.com examines the most important "bearish arguments to ignore."
Dick hits a number of themes that will be quite familiar to regular readers of "A Dash." Here is his list:
"The Bearish Arguments That Are Wrong
Three of the most persistent bearish arguments were highlighted in a recent article on a major financial web site.
The arguments are:
1) Market valuations as measured by Price/Earnings (P/E) multiples aren't low. 2) The 10-year Shiller P/E shows stocks overvalued. 3) Profit margins are high and using a "normal" profit margin shows stocks are overvalued."
I strongly urge readers to check out his article. He explains that these methods are backward-looking, do not reflect interest rates, and assume that margins will mean revert without any corresponding change in employment or gross revenue.
As I said -- arguments familiar to (and profitable for) readers of "A Dash."
A Final Thought
If you are an investor who is not mesmerized by fear, you will be able to join me in doing two things:
Finding stocks that have strong anticipated earnings and cash flow.
Finding stocks with strong dividend yield.
The Wall of Worry is a difficult concept to explain, and even tougher to appreciate in real time. The daily stories seem so tangible --- often augmented with TV video.
For a free education on this topic, you could dip into my archives.
For those in agreement on the economic theme and Europe, I like JP Morgan Chase (JPM), Caterpillar, Inc (CAT), Aflac (AFL), and Oracle (ORCL).
The dividend yield concept is more challenging, since I have an ever-changing roster of great dividend stocks where we sell calls to enhance the yield. Intel (INTC) and Abbot (ABT) are among the recent choices.
Since last May I have been reviewing the record of those who forecast the business cycle. I developed a stringent list of requirements, "Jeff's Acid Test," and I frequently invited nominations. Here were the stated requirements:
Openness -- with the potential for peer review
Small number of input variables. Most people do not understand that "small is good." If you have a lot of variables, it is easy to do back-fitting on a few cases. Beware.
Real-time performance. This means that you do not go back in history doing any data-mining. You create an indicator and live with it through time.
I received a number of suggestions in the comments and by email. I very much appreciate the help from readers. One result is that I am monitoring a number of new and promising forecasting methods. I plan a later article on the honorable mention winners.
Somewhat to my surprise, there was only one candidate who met all three criteria:
Most people think they know about recession forecasting, but they are often responding to someone's last good call or who has the best PR team. The Dieli method hits a winning trifecta -- it is based on sound intellectual premises, it has worked better than any other method in real time, and it is open for our review. What more can we ask?
Background
This is Part 2 of a planned five-part series on recession forecasting (Part 1 is here). I know that many will want to dig into the nuts and bolts of the Dieli method, and I will start that in the next segment. There will be plenty of opportunity to for comparison and discussion of various methods.
For now, let us just think about the results in terms of the long-term track record, and learn a little more about how the model was developed.
Track Records
Let's start with a look at Mr. Model.
The key variable is the Aggregate Spread, depicted by the blue line. It depends upon monthly data, and will be updated next week. The trigger point is the 200 level. Whenever the blue line crosses 200, it is a forecast of a "cycle event." The forecast horizon is pretty close to nine months. This means that when the line crosses 200 moving lower, it is a nine-month warning of a peak, AKA recession as defined by the NBER. When the line crosses moving higher, it provides a nine-month warning of a trough.
Doug Short does an excellent job with the two most popular candidates in his update article, The Great Leading Indicator Smackdown. There are several excellent charts, and I recommend reading the entire article. For our current purposes, I am selecting the one that best matches the Mr. Model forecasts.
I invite the reader to scroll from left to right, looking at the lead times for both the onset and the end of recessions. (I understand that the ECRI uses both an acceleration term and other indicators to augment their calls, but we have to start somewhere.)
It would be nice to put all of these indicators on a single chart, but I think the strength of Mr. Model is apparent.
The Man behind the Model
As background for the record, I have known Bob Dieli only for a few months. Since we both reside in the Chicago suburbs, it was convenient for us to meet for lunch after a joint appearance on a panel. I appreciated his openness, honesty, and intellectual rigor. I was even more impressed by the results of his method. When I learned that he had not tinkered with it over the years, I really perked up.
This is a very unusual combination, helping to define someone as the "real deal." Here is the interview I later conducted.
Q: Bob, tell us a little bit about how and when you first conceived the ideas behind Mr. Model?
The origins go all the way back to graduate school at the University of Texas in the 1970s, when I first became interested in the business cycle. I began to work on the model in its current form while I was doing economic research at the Continental Bank from 1978 to 1984 and at the Northern Trust from 1987 to 1994. Both were financial institutions with major exposure to the risks associated with business cycle peaks and troughs.
Q: You have had a number of high-profile jobs. Did your economic research on this topic continue through all of these experiences?
Over the course of my corporate career I spent time in staff assignments in economic research and later in line assignments in credit risk management at the Continental during the crisis that led to its implosion. In 1987 I became a fixed-income portfolio manager at the Northern, where my clients were mostly high net worth individuals.
Can you tell us a little more about how these positions helped you develop your skill as a forecaster?
The combination of those experiences gave me some important insight on the preparation and use of forecasts. I learned that details of great interest to the forecast originator may not be very important to the forecast user. The bottom line was that accurate and insightful forecasts, delivered in a timely and usable manner, were the most sought after by decision makers.
Q: You feature a chart of economic performance and model signals, with an excellent real-time record. Can you elaborate on that a bit?
My objective was to find a format that allowed the user to draw conclusions quickly. This turned out to be charts with long historical tails that provide perspective and context at a glance.
Q: You also write extensively on employment. This actually represents a second approach for your economic analysis, I think. Is it giving you a similar signal right now?
The employment figures are among the most informative statistics we have. They are the best coincident indicators of economic conditions and, as such, give you a great place to start on figuring out where we are in the business cycle and what is likely to happen next.
Q: How much lead time do you usually see between a signal from Mr. Model and an economic peak or trough?
The Aggregate Spread, which is the principal forecast statistic, operates with a constant nine month forward look. Unlike other leading indicators which operate with a variable lead time, the Aggregate Spreads looks ahead nine months at all times. Think of it in the same terms as the beam on the radar on your local weather channel. The historical record has shown that when the Aggregate Spread gets to 200 Basis Points, from either direction, we have reason to think there will be a cycle event (either a peak or a trough) some time in the time period nine months ahead of the arrival of the Aggregate Spread at the 200 Basis Point boundary.
Q: Making those calls out nine months must lead to some interesting conversations with your clients.
Indeed they do. For example, the signal for the peak of the 2001 recession that began in March of that year, came from model readings obtained in June of 2000. Telling folks, in the middle of the tech boom, that the business cycle had not been repealed and that we would have a recession the following year was a tough sell. Similarly, the indications that the recession of 2007 would end in the middle of 2009 began to emerge late in 2008 and in early 2009. Trying to tell folks that the economy would turn up while it was in the midst of what looked like a free fall in the first quarter of 2009 was even more difficult. But, because the model has the track record that it does, by the end of the first quarter of 2009 most of my readers were convinced that the worst of the recession was over and that a bottom would be forming.
Q: To make this clear, while you talk about markets, you are not making market predictions. You are predicting the economy, right?
That is correct. What I am out to do is anticipate the dates of business cycle turning points as determined by the National Bureau of Economic Research (NBER) with enough warning to allow effective planning. The stock market, the fixed-income market, and the housing market, to name just three, all have their own cycles. Sometimes those cycles match up closely with the NBER turning points, and other times they don’t. But you can’t know that until you know the NBER dates. The Aggregate Spread has an excellent record of showing, as much as a year ahead, when an NBER event is likely to take place. Armed with that information, and the specifics of their industry, or market, informed decision makers can make appropriate plans.
Q: Could you tell us a little be about your firm and its clients?
I’d be glad to. RDLB was started in 2002. My clients consist of three main groups: money managers, companies that make things, and individual investors. I send my monthly reports, which are available by subscription on my website, to all of these groups. I am available to all my subscribers for additional interpretation of the report contents. I also have a consulting practice in which I function as their economic research department. The assignments are as varied as the firms themselves, which makes the work very interesting to me. I also do public speaking before trade groups and gatherings arranged by and for my clients.
Q: Why do you call your site "Nospinforecast"?
Because the forecasts and viewpoints expressed there are completely data driven. I talk about what is on the charts. I don’t rant and I don’t take sides. I report the information and provide complete access to my forecasting methods. While I do talk about possible future outcomes, I do so within the context of numbers themselves. My objective is to provide my readers with information they can use to assess other views and forecasts as well as information they can use to effectively manage their business and financial affairs. One of the reasons I do this is because of lessons I learned while working with the trading desks at both the Continental and the Northern. The same piece of economic information might be reason for one desk, say short-term fixed income, to buy and another desk, say foreign exchange, to sell the instruments they traded.
Q: Thanks, Bob, for your helpful and informative comments.
Thank you for the chance to talk about Mr. Model.
Conclusion -- Part 2
There is plenty more to discuss. I will get into the workings of Mr. Model in Part 3. We will revisit the comparison with the ECRI in part 4. These are tentatively on the agenda for next week.
Meanwhile, everyone should note that a "cycle event" -- aka recession -- is not expected for at least nine months. Unlike those who ascribe 0% or 100% chances of events, I understand that bad things can happen.
Nevertheless, you should keep this in mind:
In the 50-year history of Mr. Model, when the indicator is at current levels, there has NEVER been a recession within nine months. In fact, we are not even close to the nine-month signal.
Suppose that your objective is to find good investments. You start by looking at the most popular sources, and what do you find?
Most of the comments have a strong viewpoint -- either political or ideological. This has an effect on the writers, since stimulating page views drives advertising, measures of popularity (which are confused with quality, even by experts), and face time on TV.
If you want to be a writer for any big-time site they expect you to have a viewpoint and to be provocative.
Am I alone in seeing the irony here? If you just take a list of the biggest "investment blogs" the ideological bias is apparent. There are only a couple of exceptions.
Today's Example
This week provided an excellent example of how the savvy investor can profit by putting aside his/her political views. I have in mind the ongoing Washington farce, this week emphasizing the extension of the payroll tax cuts and unemployment benefits (along with a few other elements of contention).
As public policy, you could question whether it was appropriate to extend benefits. Was this sending the right message to the unemployed? Should public policy be nudging the long-term unemployed into more aggressive job searches?
You could also question the payroll tax cut extension. Should we be digging a deeper hole on the entitlement balance sheet, deferring the costs until later?
You could emphasize the political horse race -- the main theme of most stories. This is what everyone wants to read. Did the Democrats gain from this showdown? Did Boehner really "cave?" What does this mean for the election. It is all a game to most people.
The Trading and Investment Edge
It is easy to take advantage of this political, partisan, and ideological bias. Just ask the following question about what is happening:
Is it market-friendly?
The tax-cut/unemployment decision meets the market friendly test because it helps to stimulate the current economy. I understand that many people believe it is wrong to spend now and pay later, but that is not the market test.
Those who wear this ideology on their sleeves and invest accordingly are losers.
Every macro-economic model used on The Street takes a different view. Whether Keynesian policies will work in the long run is a matter for debate. Whether Wall Street forecasts, mainstream viewpoints, and the actions of big pension funds follow this approach is not debatable. This is what they do, and today's market underscores the point, as you will see from tomorrow's news headlines.
How to Profit
There was actually plenty of time to profit from this. The news came out on Thursday afternoon, and there was little movement in futures. Here is what I commented at the new Wall Street All Stars Site:
December 22, 2011 - 4:24 pm
There are reports from various sources that the House GOP will accede to the two-month payroll tax cut extension. Since the House already acted on the Senate bill, calling for a conference committee (SOP) this is going to take some fancy footwork.
jeffmiller
December 22, 2011 - 4:26 pm
Whatever one thinks of the merits of this issue, I regard this as market-friendly news.
There was plenty of time to act. This afternoon I noted the reaction from one major firm. I expect more to follow:
As I said yesterday afternoon, the payroll tax cut extension is market friendly. JP Morgan raised their Q1 GDP forecast from 1% to 2.5% partly on this basis. The assumption in their report is that it will be extended for the rest of the year as well. I think that is a near certainty. Here is a link to a story describing the report: http://www.businessinsider.com/jp-morgan-raises-2012-us-gdp-growth-forecast-2011-12
A Guideline that will Pay Off
Here is the rule that is working: Anything that provides current stimulus, even if it has a later cost, is market friendly. Expect a rally.
This goes double in Europe. Any measure that delays a day of reckoning and buys time for a solution will be viewed as market friendly.
Are you trying to win a debate, or would you rather get returns on your investments?
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