A Dash of Insight

Weighing the Week Ahead: Are Earnings Expectations Too High?

The quirks of the calendar have delivered a week that has little fresh economic data.  Some will use the quiet period to continue the discussion of politics and the debt ceiling.  Others will focus on predictions for the coming year.

Most are tired of "the cliff" and will be happy to turn to a new subject:  It's time for earnings!

This earnings season will be especially important.  Here are two key reasons:

1. Forward earnings estimates are at an all-time high.  The oft-repeated pundit opinion is that analyst estimates are excessive and must be reduced.
2. The January earnings season often includes full-year guidance.  This is always interesting, but perhaps even more so right now.

Both of these intriguing ideas come from my Chicago-based friend Brian Gilmartin, who is among the very best sources on corporate earnings.  He sees the forest, since he has tracked the ThomsonReuters estimates for over a decade.  He notes trends in these estimates as well as revisions by sector, most recently with this report at his blog.  He also covers many individual stocks through his posts on Seeking Alpha.  (see his Alcoa preview).

I have some thoughts on this earnings season, which I'll report in the conclusion.  First, let us do our regular update of last week's news and data.

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 other events.

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:

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

The Good

The holiday-shortened week still had a lot of significant news, and it was mostly positive.

• The Fiscal Cliff decision.  Those who object to this being scored as "good" should re-read the criteria, e.g., market friendly.  They also need to separate their political opinions from economic reality.  The decision avoided an immediate economic drag from the expiration of tax cuts and the sequester.  This was good for the economy and good for stocks.  Those who are complaining the loudest about the outcome are the same people who were completely mistaken in their forecasts.  I recommend that real investors ignore these sources and read my review of the outcome.  There are obviously important remaining issues.  I'll get around to those when it is more timely --- which is not right now!
• The ISM index is back above 50.  Bespoke has a good discussion of the trends in the sub components, including this chart:

• The ISM services index was even better.  See Steven Hansen's comprehensive discussion, including the various components.
• Shadow home inventory is down 12% according to CoreLogic (via Calculated Risk).
• Commercial lending is higher, along with many other growth indicators.  Scott Grannis is not happy with the election result or current tax policy, but he is open-minded in looking at indicators.  See the full article for all ten of his charts.  Here is one example:

• The technical picture is better with an upside-down head and shoulders playing out, among other patterns.  The analysis is not that simple, and difficult to summarize.  Charles Kirk's success reflects his willingness to change with the data.  His site has a small charge which goes to charity after offsetting expenses, and it is well worth it.  He provides this week's update while fighting the flu.  Get well soon, Charles!
• Europe continues to improve.  Remember the threat of rates over 7%  Dominoes falling?  You can either listen to the words of those singing the same song, or you can look at data.  Dr. Ed notes that the mission is being accomplished even without actual sovereign debt buying by the ECB.

The Bad

There was not much bad news last week.  I invite readers to nominate items that I overlooked, but make sure that they are fresh -- not just stale and recycled opinions.

• The FOMC minutes.  These are usually not controversial, but the new era of transparency from the Fed seems to be backfiring.  Despite the meeting decision to increase the QE program, to some the minutes seemed to suggest that a policy change might be imminent.  This is a good topic for more work, so it is high on my agenda.  Meanwhile, I recommend the comprehensive discussion from Cardiff Garcia at FT Alphaville -- a careful look at various perspectives.  I also like the account from Paul Vigna at MarketBeat.

"Investors aren’t looking at the fundamentals through their own eyes, but through what they think the Fed thinks, and trying to gauge when the Fed will send a signal to everybody else that it’s going to change course. Because if you’re really playing this game, you’re trying to catch that signal from the Fed before every other trader, speculator and investor does."

 

• Manufacturing new orders disappointed.  See Steven Hansen's report for all details.

The Neutral

Employment.  I do not do a neutral category very often.  I want to mention the employment report, but I cannot bring myself to call it "good" in the current market context.  It was certainly not "bad."  The job growth is consistent with recent months, which means that it is positive, but far less than what is needed.  The report avoided the customary complaints about seasonality, labor force participation, and manipulation of data.

We need businesses to start hiring more aggressively.

The Ugly

This week's ugly award goes to the "sold out bull."   I tried to explain why those who missed the "fiscal cliff rally" should simply understand that it was not all about price --- it is a matter of risk and reward.  If you choose to avoid the high-risk situation (and what turned out to be the best price), there is no shame in buying after the risk is lower.  It can be quite smart, and more consistent with your objectives.  Very few understand this concept.

Josh Brown is more expressive and colorful, and I recommend the full piece.  As usual he absolutely nails the market psychology of those who have been left behind.  We can all learn from this:

No, the sold-out bull is pure evil - ferociously outspoken or slyly suggestive, he is all the time engaged in a singular mission:  Scaring others out of the investments that he would like to buy back himself at lower prices.

The sold-out bull is a sickly creature, a thrashing fish on the deck of a ship, out of its element and sucking at the air for one more breath. Every trick will be employed, from fiery sermons of impending doom to sarcastic asides about the dopiness of those who are still in.

The sold-out bull is desperate and his mind is twisted, every thought and expenditure of energy is employed toward the creation of a lower entry back into the markets. Only a cheaper buy-in will vindicate the earlier decision to sell that haunts him so.

Steer clear of the sold-out bull, for the ferocity of his bearishness comes from somewhere very dark and extremely cold. He will hurt you if he can, climb over your body to get back in.

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."

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting.  His latest verdict is that the ECRI has flunked Recession 101! I have been expecting the ECRI to declare that their forecasted recession is over.  The secret long-leading indicators have been identified by some, and they have improved since the original forecast.

RecessionAlert uses a variety of different methods, including the ECRI, in developing a Super Index.  They also offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.

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.  A month ago we switched to a bullish position.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix's ratings stabilized at a low level and improved a bit over the last few weeks.  The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure is moving higher, so we are becoming less confident in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

 

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

• Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

The "B List" includes the following:

•  Trade balance (F).  Continuing implications for the GDP.
• The JOLTS report (Th).  Mostly helps on the issues of structural unemployment and letting people see the gross job changes.  Not much movement in recent months.

There are a number of Fed speeches on tap.  Given last week's news, this may be more confusing than enlightening.

Most important is the start of earnings season.

Trading Time Frame

Felix has moved to a bullish posture, now fully reflected in trading accounts. It has been a close call for several weeks.  Felix has done very well this year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago.  Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral.  Our current trading holdings have a foreign tilt.

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.

Buying in times of fear is easy to say, but so difficult to implement.  Almost everyone I talk with wants to out-guess the market.  The problem?  Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Even the pros get it wrong.  Any of us who are constantly commenting on markets will have some bad calls, but last year was worse than usual.  Bloomberg's Michael Patterson & Lu Wang write, Almost All of Wall Street Got 2012 Market Calls Wrong.  Citing some of the most prominent forecasts, they write as follows:

All of them proved wrong last year and investors would have done better listening to Goldman Sachs Group Inc. (GS) Chief Executive Officer Lloyd C. Blankfein, who said the real risk was being too pessimistic.

The ill-timed advice shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”

“They paid too much attention to the fear du jour,” Jeffrey Saut, who helps oversee about $350 billion as the chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 2. “They were worrying about a dysfunctional government in the U.S. They were worried about the euro quake and the implosion of Greece and Portugal. Instead of looking at what’s going on around them, they were letting these macro events cause fear to creep into the equation.”

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).

Final Thought

How can you go wrong by under-estimating Congress and other political leaders?  Amazing!

But that is what happened.  Even modest expectations for results was enough to keep you on the right side of the market.

For the upcoming earnings season I remain open-minded and I will be very attentive.  Last quarter was a minefield for corporations.  If the complete story -- earnings, revenue, outlook -- was not perfect, the stock price moved lower.  I avoided earnings dates in our most aggressive trading programs, and I was nearly always right.

So what now?  We all know that the economy remained sluggish in Q4, so earnings will not be great.  Much of the uncertainty has been lifted.  We know the election result and also tax policy for the near future.  Will companies provide a little more guidance?  What will it be?

I have more respect for the analyst updates than I do for the pontificating pundits with opinions but absolutely no record.  I understand that analysts are too bullish in their multi-year forecasts -- basically following trends with no allowance for bad news.  I also understand that by the time earnings are actually reported, the bar has been lowered so that more than 60% of companies beat expectations.

Most experts share these views, but I seem to be alone in drawing the logical conclusion:

If estimates are too bullish in the long run and too bearish at the time of the report, there must have been a "crossover date" when the forecasts were pretty good.  My research shows that this occurs at about one year in advance.

To summarize:  This earnings season will be important for estimate revisions as well as the current "beat rate."

Fiscal Cliff Notes: Interpreting the deadline news

Here is an all-time first:  Market rallies on news that Congress will be in session!

That was today's story.  The market gyrations lacked a grounding in reality.  Joe Weisenthal charts the day, with my comments to follow.

Here are a number of rhetorical questions:

• After weeks of public posturing on both sides, would we really expect Reid, McConnell or Boehner to make a conciliatory speech from the floor?
• Did we think that Obama would come back early from vacation without even a rumor of a new plan?
• With 100 Senators and 435 Congressmen, do we think that they will all remain silent as negotiations proceed?
• Perhaps we should expect that many will be claiming a few minutes of fame without any new information at all!

If you were making trades by accepting this "information" you were on the wrong side today!

The Reality

While the market is following the public news sources, including anyone who will go on TV, none of this information is very helpful.

There have been continuing back-channel discussions at the staff level.  There is also escalating pressure, especially on Republicans, to reach some kind of deal.  The doctors, those affected by the AMT, and the business executives stymied by uncertainty are mostly from the GOP.

If they had a chance to vote on a compromise proposal, many GOP legislators would support a compromise.  The compromise would be close to the most recent Obama/Boehner discussion, with perhaps a little more concession from the President on spending.  While there is support for such a plan, there is a key problem of who goes first, both in terms of party and also which House.  Revenue bills are supposed to originate in the House.  This partly explains why the Senate-passed bill on the Obama plan has never formally gone to the House.

This is only going to work if the Senate finds a compromise, without a filibuster, that Boehner is also willing to accept for a House vote.  There is still some possibility of this, and we may well know the verdict tomorrow.  The path to a compromise would start with the Senate considering such a proposal.  The House would take it up on Sunday.

The other alternative is the "bungee jump."  I have noted that legislators are creative when it comes to deadlines.  They might extend their deadline by going "over the cliff" while sending a message that there will be an early vote by the new Congress.

The Nature of Compromise

I enjoyed reading the description of compromise from Alan Grayson, a Democratic Congressman-elect from Florida.  To appreciate the key point, don't think about his particular perspective, but instead focus on the process he is describing:

"Here are what I modestly and humbly refer to as "Grayson's Laws of Legislating":

1) Vote for what you're in favor of.

2) Vote for what you can live with, if you must do that to get what you need.

What we've been seeing in the House of Representatives lately has been a series of massive and pervasive violations of Grayson's Laws of Legislating. Instead of "I'll vote for X because it's right," or "You don't like X and I don't like Y, but I'll vote for X and Y if you vote for X and Y," it's "If I don't get Z, I ain't votin' on nothin'." And that's the problem."

He provides a colorful example of where nearly everyone in Congress agrees on most of the fiscal cliff issues.   On the remaining 10% he provides a colorful example of trading help for the unemployed for more defense spending.  It is a good description of how Congress has worked for decades.

The key question is whether we can see this sort of horse trading within the next few days.

Trading and Investing

The volatility is a natural opportunity for traders.  You need only to fade the statements of whatever politician spoke most recently.

Investors should look a month or so ahead.  If you are willing to conclude that there will eventually be a solution, you can go shopping for bargains whenever there is apparent bad news.

These were today's opportunities, and we might well see the same thing tomorrow.

Obama Silences Political Scientists!

Did you hear this news, prominently featured on talk radio?

The American Political Science Association Annual Meeting. ... It's a chance to introduce highlight criticism of policies to a lot of people. And I noticed that the hurricane center's track is -- and I'm not alleging conspiracies here. The hurricane center is the regime; the hurricane center is the Commerce Department.

It's the government.

It's Obama.

And I'm noticing that that track stayed zeroed in on New Orleans day after day after day. And the APSA reacted to it accordingly, canceling the entire convention. What could be better for the Democrats than the egghead profs cancel their meeting? Even though the media wasn't going to televise a lot of it anyway, they can't televise it if it isn't happening.

 

[Humor Alert!!  Undaunted by the confusion from my last effort to educate through humor, I am trying again.  Sometimes it is helpful to start with something so outrageous that it is obvious to all.  Then you gradually move to equally silly ideas that actually have plausibility for some.

There is an important investment lesson here in the conclusion, so bear with me.]

The fake quotation above is almost true.  The only changes are that the APSA has been substituted for the GOP and New Orleans for Tampa.  (HT to Brett LoGiurato at Business Insider for the original story).

This is a great example of misunderstanding how the Federal government works.  Here is the real story. Radio host Rush Limbaugh claimed that President Obama was ordering the National Weather Surface to forecast the hurricane's path towards Tampa specifically to disrupt the Republican National Convention. On Wednesday, Limbaugh said:

"The National Hurricane Center, a government agency, [is] very hopeful that the hurricane gets near Tampa...The National Hurricane Center is Obama. The National Weather Service is part of the Commerce Department. It’s Obama...I can see Obama sending FEMA in in advance of the hurricane hitting Tampa so that the Republican convention is nothing but a bunch of tents in Tampa. A bunch of RVs and stuff. Make it look like a disaster area before the hurricane even hits there."

Two Mistakes

First, this is a classic example of one of the most common fallacies people have about government. Keep in mind this isn't any sort of partisan issues.  Pundits of all stripes are susceptible to this same sort of thinking. The temptation to view bureaucracy as a monolithic entity, always obeying the President, is strong, but severely misguided.

In fact, the relationship between any US President and the federal bureaucracy is very complex. The scientists and bureaucrats working in the National Weather Service have long careers that transcend several presidential administrations. The so-called skeptics who suggest conspiracy at every turn should stop and think of Occam's Razor: That which can be asserted without evidence, can and should be dismissed without evidence.

Second, it is what I call "light switch thinking."  Most events involve probabilities, not a "yes or no" outcome.  No matter what the outcome in Tampa or New Orleans, the risk was there.

No matter the outcome on the policy effects of Bush, Obama, and the Fed, the actual result must be compared with what would otherwise have happened.

Is this Important?

To my surprise, a significant fraction, over 20% of my economic blogging colleagues in the regular quarterly poll conducted by Tim Kane (now at the Hudson Institute, doing a new blog with Glenn Hubbard -- best of luck on both fronts!), continue to believe that government data paints an overly rosy picture.  Check here for all of the results.

We see this kind of reasoning repeatedly, as multiple sources criticize government data.  Typically they think that the President has the power to cook the books.  In fact, the top-level statisticians spend careers trying to get everything right --- imputing job creation, measuring inflation, and doing seasonal adjustments.  The people criticizing the data have no background, no education, and no experience.

Professional policy anlaysts take pride in speaking "truth to power."  This seems to have been replaced by those serving up lies to the masses -- telling them what they want to hear.

Investment Take

There is an important investment lesson, and it is simple.

There is a bull market in deception.

Sometimes the motive is politics.  Other times it is selling gold.  It might be a lucrative deal with a hedge fund, perhaps steering funds to manage.  It could simply be pandering for page views, since the conspiracy story sells best.

A reader alerted me to this humorous item.  Shadowstats, which was thoroughly discredited here and here, continues to  be the go-to source for those seeking to paint a picture of disaster.

One of their predictions has been a multi-decade forecast of hyper-inflation, supposedly unrecognized by government data.  Let's check the prices:

Shadowstats subsrciption six years ago:  $175.

Subscription now?  $175.

If you want to follow economic progress, you need only follow the data.  If you want to cater to your pre-dispositions, you can always find a source that will spin your way!

 

Romney? 100% Chance of Recession!

In the entire history of official recession dating (beginning in the 1850's) there is a startling fact:

Every newly-elected Republican President has brought a first-term recession.  All of them.  "Always and only" as we hear from a popular data-mining pundit.

You can check out the list of GOP Presidents here.  And the official recession dating here.  I use "elected" because there was no recession in the brief term of fellow Michigan man Gerald Ford.

It is not quite "only" since Democratic Presidents avoided recessions on a 10-2 basis.  I am not surprised that there was no first-term recession for Bill Clinton or JFK, but who would have expected a clean record for FDR or Jimmy Carter?

Economic Comparisons by Party

According to this Bloomberg article, Democratic Presidents Are Better for the Economy.  The author, Richard J. Carroll is an economist at the World Bank.  Here is a summary of his findings:

The Truman legacy has truly grown over time!

Here is another study that says Democrats win on a balance of economic indicators, 11-2.  The authors conclude as follows:

"President Barack Obama does not feature in the rankings, as he has not yet completed a four-year term. But if Obama were evaluated now on all 12 of the indicators, he would fall somewhere in the middle of the pack, Deitrick says. The bottom of the pack overall is populated by Republicans: Presidents Richard Nixon, Gerald Ford, George W. Bush and Herbert Hoover."

Lessons in Inference

I trust that readers will understand my tongue-in-cheek approach to this subject.  It is silly to conclude, based on this evidence, that electing Romney will lead to a recession.

Meanwhile, many people use similar evidence to make bold claims about recessions.  Their readers consume the pseudo-scientific claptrap and blindly follow the pundit to a dubious decision.

If you agree with me that the conclusion about Romney is not valid, then maybe you need to reconsider the work of the guy who keeps describing a syndrome involving his Aunt Gertrude.  The methodology -- using many years of backfitted data -- is just the same as you see here.

Causal Modeling

Causal reasoning in economics involves many variables.  Especially when the number of cases is relatively small and the number of variables is large, the causal model can be tricky.

Try this one:  When a Republican is elected, it is often the result of Democratic economic failures.  This means that the GOP winner is saddled with a bad economy.

See how easy it is to create reasons after the fact?  Check out one of my favorite stories from "the old days."  The smarter you are, the easier it is to fool yourself.

Investment Conclusion

If you understand this article, you can win an Olympic all-around medal!

1. Separate politics from your investments;
2. Ignore bogus pseudo-science;
3. Beware of recent trends in both fear and greed;
4. Look for stocks with attractive valuations.

Each week I summarize the very best recession forecasts.  Since those with the best records are not featured in the financial media, this gives thoughtful readers an advantage.  Those scared witless by the recessionistas are selling cyclical names and tech stocks while piling into defensive sectors and dividend stocks.

The comparative valuations are becoming extreme.  I favor early-stage cyclicals like Caterpillar, Cummings, and Illinois Tool Works.  I like tech stocks including Apple, Oracle, Microsoft, and Marvel.

When I look for "dividend stocks" I am not seeking those with super-high yields, but strong balance sheets and PEG ratios, where I can also sell calls to enhance the yield.

The individual investor can find many good opportunities, but you must start with a good grasp of the business cycle.

(HT to Bob Dieli, whose whimsical comment inspired this post.  And no, the election result is not one of the factors in his excellent system, Mr. Model.)

 

 

 

 

 

June Employment Report Preview

We rely too much on the monthly employment outlook report.  It is a natural mistake.  We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.

Since the subject is so important, most people place too much emphasis on the official (preliminary) report, which is really only an estimate.  In about eight months, we'll have an accurate count from state employment offices, but by then no one will care.

There are several competing methods that provide independent approaches to analyzing employment.

I will first summarize the BLS official methodology.  Next I will review alternative approaches and those forecasts.  I will conclude with some ideas about what to watch for.

The Data

We would like to know the net addition of jobs in the month of May.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

1. An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
2. The report is revised to reflect additional responses over the next two months.
3. There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone.
4. The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low. (See here for a more detailed account of this, along with supporting data).

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. What we are all looking for is information about job growth. There are several competing sources using different methods and with different answers.

• ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 176K private jobs on a seasonally adjusted basis.  In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate.

• TrimTabs looks at income tax withholding data. The idea is that this is the best current method for determining real job growth. TrimTabs forecasts gains of about 75,000.  Despite an admitted mistake in their methods earlier this year, I always cite their approach as worth serious consideration.

• Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).
  
  • Jeff Method.  I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines.  From my perspective, the decline in consumer confidence, even with lower gas prices, is disturbing.  It is difficult to account for the effect of headlines about Europe and the fiscal cliff.
  • Street estimates generally follow my method, but few reveal much about the specific approach.  Have a little fun by looking at the specific forecasts from many firms, along with a picture of the spokesperson!  Thanks to Business Insider.  Joe Weisenthal, in a good story about Goldman,  notes that some of these estimates are already responding to the ADP report.
• Briefing.com cites the consensus estimate as 100K, the same as their own forecast.
• Gallup sees unemployment as falling on a seasonally adjusted basis (but flat if unadjusted).  This is interesting since they have a different survey from the government, a relatively new approach to seasonal adjustment, and an extremely bearish and political approach in past commentaries.  Gallup's methods deserve respect, so I am watching closely.

Partial Indicators 

A problem with forecasting net employment changes is that you need to look at all of the following:

1. Both hiring and firing;
2. Companies of all sizes; and
3. Failing companies and new businesses.

There are many interesting pieces to the puzzle, but it is easy to over-react without the context listed above.  The respected Challenger survey reports fewer layoffs.  Excellent!  But does that mean hiring?  Initial jobless claims move higher.  That tells us about job losses at certain types of firms, but nothing about job creation.

An interesting idea comes from Michael Mandel, who astutely notes the disparity in help-wanted ads according to the occupation.  Harkening back to The Graduate, Michael (one of my favorite acquaintances from my Kauffman meetings), writes as follows:

"If you have a college student in your family who is looking for a job, remember this one word: 'Data.'"

For Dustin Hoffman it was "plastics."  Michael says to watch this, so I am and you should, too.

Men on a Mission

(And women too, of course, but I could not resist the alliteration.  Biased female economists should feel free to accept equal blame!)

Here at "A Dash" we have great respect for those who make objective, independent forecasts.  We know that methods may lead to different conclusions, and that debate is healthy.

With this in mind, here are two examples:

1. TrimTabs confidently asserts that the BLS data will be wrong!  Amazing, without knowing the content of the report or the revisions.  They assert that we are in a "depression" and are confident about the direction of later revisions.  While I have been sympathetic to their own mistakes, and agree about revisions, they do not seem to realize that the BLS has been understating growth for a couple of years.  Why the agenda?
2. David Rosenberg is out with a list of reasons why the jobs report will "stink."  He cites a number of interesting indicators.  A serious economist would do research with a time series on each, discarding those that reflected multi-collinearity.  That is what my team did.  He cherry picks reports and plays the same tune, always finding new data.  He has an audience, and one much bigger than mine!  [Will someone please remind me of who first said that the crowd expects Neil Diamond to sing Sweet Caroline?  I want to give credit where it is due.]

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

• Focus on net job creation.  This is the most important.  The big story is the teeming stew of job gains and losses.  It is never mentioned on employment Friday.  The US economy creates over 7 million jobs every quarter.
• Failure to recognize sampling error.  The payroll number has a confidence interval of +/- 105K jobs.  The household survey is +/- 450K jobs.  We take small deviations from expectations too seriously -- far too seriously.
• False emphasis on "the internals."  Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy.  In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
• Negative spin on the BLS methods.  There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment.  This is a propaganda war that seems to have ended years ago with a huge bearish spin.  For anyone who really wants to know, the BLS methods have been under-estimating new job creation.  This was demonstrated in the latest benchmark revisions, which added more jobs, as well as the most recent report from state employment offices.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

Trading Implications

My experience with employment Fridays is that there is little benefit to being aggressively long before the report.  The spinfest usually provides shorts with a morning "dip to cover" when the number is surprisingly good.

I also expect some dampening in either direction.  A really bad number will be met with expectations for Fed action.  A strong number will get the opposite result, and maybe a stronger dollar.

Unless there is a massive discrepancy from expectations, my guess is that we will move on to earnings season and option volatility will be reduced.

And most important.....investors should not let this become political, even though the pundits will.

Weighing the Week Ahead: A Search for Leadership

I cannot do justice to the concept of leadership in one article, but let us hit the highlights.

Leadership is what most market commentators want when they complain about "politicians."  They want leaders of democracies to ignore the demands of constituents and do what is right.  Unfortunately, the punditry has widely varying views on the best course of action!

The search for leadership is hitting center stage.

Leadership requires more than accepting and following opinion polls.  It includes finding solutions and convincing people that this is the right path.  Bringing contending parties together.  Finding compromises.  Personal charisma.  A persuasive presence.  Confidence in the face of crisis.

The need for strong leadership is readily apparent, but why the focus right now?  I see three factors:

1. The upcoming Greek election, which may well determine whether Greece leaves the Eurozone and on what terms;
2. Increased urgency among European leaders, as austerity programs fail both with voters and in economic results;
3. Intensifying US politics, with a new focus on the personal skills of the candidates.

This last point, highlighted by Obama's press conference comments, will be the big topic for the weekend talk shows and featured in financial news this week.  It is difficult to find a really neutral link for this subject, and you can easily find many on your own, but this coverage from Business Insider provides both facts and context.  It shows the actual statement and plenty of quotations from Republicans, but also some data.

I'll offer some 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:

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

The Good

The US economic data last week was more positive than in recent weeks.

• Technical selling was averted.  This was a big fear last week.  Josh Brown did a great job of explaining why this might not happen.  I hope readers followed our link to his analysis.
• ISM Services index showed continued expansion.  Steven Hansen does a good job of analyzing the internal elements and also provides a helpful chart.
• Spain has agreed to accept outside aid for its banking system.  The $125 billion is three times the amount cited by the IMF as needed.  (New York Times).  The terms were structured with an emphasis on bank reforms rather than new austerity measures.  German officials praised Spain.  This is the sort of face-saving compromise action that investors should be watching as a sign of progress, as I suggested in my Europe surprise ending article.
• Sentiment continues to be very negative, which is positive for markets.  Steven Hansen highlights the increased bearishness in the Ticker Sense survey of bloggers (including "A Dash).  The Bespoke Investment Group shows the same picture for individual investors.

 

• US household balance sheets are $1 trillion better than in 2007.  Scott Grannis notes that this has not led to the widely-predicted economic implosion.

The Bad

There was also some bad news on the economic data front.

• France lowers the retirement age by two years, to age 60 for some workers.
• The European bank"job" continues -- good story from Floyd Norris at the NYT.
• US debt will reach 200% of GDP by 2037, according to the CBO, if Congress extends current tax policy without cutting entitlements.
• Initial jobless claims remain at unacceptably elevated levels.  I see this as the most important of the weekly data series.  The chart from Doug Short shows why:

• Big US banks face downgrades according to the WSJ. 

"Moody's Investors Service has said it is likely to reduce by the end of June credit ratings for 17 large global banks, including five of the six biggest U.S. financial firms by assets. The downgrades are expected to raise borrowing costs and crimp some lucrative trading businesses at the banks...."

• PMI reports from around the world have been weaker.  Dr. Ed Yardeni has a good discussion about the differences between the US, China, and Europe.  The US is holding up best, but there is a general weakening pattern as you can see from this chart:

The Ugly

The Greek television talk show wins this week's "ugly" award.  The  neo-Nazi politican is now on the lam after slapping and slugging a woman from the Communist party.  The New Athenian is one of our featured sources, so we recommend this video of the incident, where John Psaropoulos does the reporting.

Speculation ranges widely on what effect this might have on the upcoming election.  No guesses here!

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." 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.

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.

 

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" and were 1/3 short via DOG in trading accounts during the week.  The ratings are close to neutral.  There are sectors in the buy range which might emerge from the penalty box, so this is a very fluid situation.  It is bearish, but marginally so.

[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

I was correct last week in my prediction that the financial news would have a Fed fixation.  All of the Fed speeches, including Bernanke's testimony, passed uneventfully.  The Beige Book showed a the economic strength that the Fed sees but traders do not.  Yellen offered some QE hope, but Bernanke did not.  We are now waiting until next week's FOMC report without any further direction.

There is plenty of data this week, but little that I see as important.  I don't expect much on the inflation front and I do not care about regional surveys like the Empire State Index.

On Thursday we will see initial jobless claims, still in the survey period for the next employment report.  On Friday we get industrial production, capacity utilization, and Michigan sentiment.  Then we get pre-weekend speculation about Greece and options expiration.

I expect the first part of the week to focus on the leadership questions, with attacks on Obama as "out of touch."

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 and another 1/3 in an inverse (short) ETF, as I predicted last week.  Felix has now sent the bond position to the penalty box, so we have a cautious short position.

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.

To highlight the continuing discrepancy between headlines and the economic fundamentals, let us look to Dr. Ed.  He compares various alternative investments to stocks, using the trailing earnings.  This chart summarized a point that was widely observed in the past week.

The earnings yield from stocks, when compared to corporate bond yields, is at a 50-year spread.  This suggests extreme skepticism about corporate earnings.  Another way to view this is that it is the greatest fear since the mid-70's.  If the two lines simply met, the S&P 500 would have to rally by 27%.  This is conservative, since you can see that the bonds usually trade at a higher yield.  If you used forward earnings or Treauries, the so-called Fed model, you would get an even larger discrepancy.

The biggest mistake that individual investors make is bad timing by following headlines.  Using data is a way to avoid that.

Long-term investors who ignore this warning can follow "Plan B."  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 over the course of a market cycle. You can, too.  With the increase in volatility, there are many good opportunities.

Final Thoughts on Leadership

I have a very good record of predicting what will happen, especially on political events.  Eventually this pays off, since earnings follow and stock prices eventually track earnings.

My concern is that sometimes perceptions create their own reality.

Suppose you are considering a major business expansion -- a new product, new plant, or new employees.  Economic uncertainty is the enemy of such plans, since you have less confidence in your forecasts.

Suppose your family is considering  a new job, a new home, or a new car.  Uncertainty can create a delay.

This is why the effect of leadership is important.  Even if all will eventually end well, people need to have some confidence.  Otherwise, why not wait until after the Greek elections, after the Europeans solve the problems, after the fiscal cliff is addressed, after the US elections......

This is why the extended US political process is so destructive, particularly when it incorrectly focuses on the personal competence of the candidates.

Here is a secret:  The things most important to investors will be fine no matter who is elected.  Both candidates are competent and will have great supporting teams.

The perceptions create an economic drag, but investors who wait for everything to be fixed will be buying at Dow 20K.

This is a challenging subject and I need more articles to explain.  Meanwhile, I try each week to highlight the most important things I am following.

 

Why Not to Panic about Europe

I feel no panic about Europe.

This is a typical test.  Every long-term investor considers the question of risk tolerance and understands that markets will fluctuate for mysterious reasons.  So far, so good.

Then, when the event actually happens, it is accompanied by a cacophony of fear mongers -- all claiming that this is "the big one."

How can the average person tell the difference?

Knowing What to Ask

The first step in critical thinking about a problem is asking the right questions.  How about these?

1. Is there systemic risk?  By this I am asking whether we have another "Lehman event" where there is a lot of unknown counter-party risk and the credit system freezing up.
2. How big is the problem?  Let us suppose that Greece defaults on debt.  Or leaves the Eurozone.  What is the worst case?
3. How do political events affect the prognosis?  We have election results where leaders and parties less willing to accept austerity have done well.  What does this mean?
4. If some countries back off from "extreme austerity," what will be the response?  Will other institutions step up?  Can there be a new bargain?
5. If everything goes wrong -- absolutely no mitigation from the ECB, the IMF, or other participants --what will be the effect on the European economy?
6. If the European economy falls into a deeper recession, what are the implications for the US economy?
7. If the US economy is weaker, what does it mean for corporate earnings?

The Superficial Answers

Most of the commentary we see has three steps:

1. Some problem in Europe
2. Cockroach/contagion/domino
3. Disaster for the world

This type of  commentary ignores any policy reaction, and also often insults the leadership of European nations, the IMF, and the ECB.

This approach is popular and gets a lot of page views since there is an active response network making these the most popular  media sites -- whether blogs, online MSM, or TV.  It is an easy story, playing to preconceptions and simple analogies.

The Danger for Investors -- and What to Watch

As is always the case, fanning the flames on these stories is what drives ratings and page views.  When the market dips, it seems to provide a confirmation of accuracy, even though the evidence is skimpy.

It is challenging to refute.  You must write an article about what is not happening!

It is doubly challenging since some of the best sources are the big-time private research firms.  Their business models are based upon fees, not page views.  This means that most investors -- including readers of "A Dash" -- do not have direct access to this information.

I suggest that investors read very critically when a story suggests causal relationships that lack specificity or quantification.  Be even more suspicious when the story ignores policy responses.  And finally, how about some quantification concerning Europe's impact on the US economy?

My own conclusion -- familiar to regular readers -- is that the European story is an ongoing process of bargaining and compromise.  US observers are far too ready to impose their own value judgments on other countries and cultures.  The exact trade off of austerity, bank recapitalization, central bank intervention, and rescue funds is a work in progress.  The exact nature will change and I still expect new entrants.

The long-term impact on the US is exaggerated by these fears.  The short-term impact reflects currency trading and (perhaps) the need for some European institutions to repatriate funds.

A Final Thought

For the average investor, a subscription to the prestigious BCA Research reports is not practical.  If you have an advisor with access, you would at least have indirect knowledge of their most recent macro commentary, including the following as part of "Apocalypse (Not) Now":

• Euroskepticism in Europe: Overstated and understudied, mainly since the media does not do its homework.
• Firewalls sufficient to protect Spain.
• The expected fiscal drag from pending policy decisions is limited, manageable, and subject to improvement if risks increase.

These conclusions mirror my own.  I will try to elaborate further on each theme, but I want to emphasize the most important point:

Policymakers have been responsive and flexible.  Skeptics have consistently underestimated the willingness and resourcefulness of the relevant institutions.

The dumbest commentary is from those who use the phrase "out of bullets."  This is exactly what people said about the Fed before the alphabet avalanche.  Whether you liked those programs or not, they were unexpected and powerful.

The current result is that economically sensitive stocks are on sale, including those (like CAT) which have little European exposure.  US financials that will benefit from European asset sales (JPM) are also moving lower for no good reason.  The over-simplified "Risk-off" mentality confers an advantage on those who do stock picking.

 

Weighing the Week Ahead: Here Come the Candidates!

In a light week for economic data, we can expect more attention to elections both in Europe and the US.

Political activity provides both an opportunity and a trap for most investors.  It is so easy to use our own electoral preferences in forming conclusions about economic and investment prospects.

Just as Democrats did when President Bush was in office, Republicans now want to make the economy seem as bad as possible -- and hopeless unless Obama is defeated.  This means super-spinning of every story.  This week's employment report is a good example.  Read Derek Thompson's fine article, The Official Guide to Spinning the April Jobs Report, to get your inoculation against the upcoming silly season.

Now that the Republican candidate is known this will get much worse.  The Hill notes that for Obama, the gloves are coming off.

In the conclusion, I'll offer some thoughts on how investors  can take advantage of the political noise.  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:

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

The Good

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

• The debt ceiling issue will not be revisited until after the election (via The Hill).  This is one of those worries that people keep bringing up, but is then ignored when it proves not to be true.  There is still a lot of heavy lifting scheduled for after the election, of course, but that is a very different problem.
• Corporate earnings have been stronger than expected and so have revenues. Some observers continually write that earnings estimates are too optimistic. When the beat rate is excellent, they then say that the bar was set too low.  Which is it?  Here is a good chart from Dr. Ed:

• ISM Manufacturing rebounded to 54.8.  The "internals" in this report were all good.
• Gasoline pump prices may move lower, a boost for the consumer.  The Bespoke Investment Group observes, "No matter how you look at it, current prices for gasoline are high, but if the recent trend of lower prices continues, it could provide a strong boost to the consumer."  Here is one chart, but check out the article for further analysis.

• Initial jobless claims (not part of the employment survey period) moved back to the prior range.  Here is the nice chart from Doug Short (but see the full article for much more):

The Bad

The most important economic news of the week was the jobs story -- a big disappointment. There was some other bad news as well.  I warned in my regular employment preview last week that we could have a disappointing number with big revisions.  The BLS method for estimating new job creation has been missing on the low side, according to the most recent actual data.

• The earnings beat rate is declining since the start of the season (via Bespoke).

• The ISM services index dropped sharply and missed expectations.  Steven Hansen notes the decline, but focuses on the overall trend.  See his complete report.
• Employment growth for April was poor.  The payroll jobs gain was not enough to reduce unemployment.  The reduction in the unemployment rate came from a reduced labor force, not more jobs.  We did not see improvement on hours worked or the hourly wage.  The household survey showed a decline in jobs.  Steven Hansen at GEI includes some ideas and charts you probably did not see elsewhere, concluding that it is not pretty, but there is continuing  modest economic expansion.

Steven is consistent in his analysis, unlike others who, for example, only talk about the household survey when it declines.  It has actually been showing much greater increases than the payroll approach.  Eventually the two come into line.

This was the big report of the week.  It turned out to be an anti-Goldilocks number:  Not strong enough to reassure about growth, nor weak enough to suggest more QE from the Fed.

The Ugly

This week's "ugly" award has to go to the stock market, where the reaction was disproportionate to the employment data.  There were clearly many itchy fingers looking for confirmation of the "sell in May" meme.  Charles Kirk provides the evidence:

 

Part of the decline was a reaction to stories about Apple suppliers.  Jay Somaney, in his trading diary at Wall Street All Stars) pointed to the real story -- a change in the needed parts -- bad for suppliers but not for Apple.

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 Silver Oz, writing at The Bonddad Blog, for his article, Once Again Zero Hedge is Completely Clueless.  One of the Tyler Durdens at ZH managed to mis-represent both the seasonal adjustment process and the birth/death adjustment in making the jobs report seem even worse.  Silver Oz points out the errors and concludes as follows:  

"Chalk this up as yet another reason to NEVER, EVER listen to Zero Hedge when it comes to interpretations of statistical reports."

Trying to correct these errors is a really thankless task.  Many of the ZH arguments have just enough data and apparent plausibility that effective refutation is very time consuming and provides little payoff.  This is why so much bogus analysis lead the Internet hit parade.

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 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. Bob has graciously offered the most recent report as a free sample for our readers.

The big news on the recession forecasting front this week came from The Bonddad Blog's continuing coverage of John Hussman's recession prediction.  (Since the Hussman recession forecasting started relatively recently and relied on tweaking and backfitting, I have not included it in the group that we analyze at "A Dash.")  This sort of "modeling" should not be expected to provide solid forecasts and it is not doing so in real time.  Check out John Hussman's recession index just blew up for the full story.

"The icing on the cake is that the "all clear" signal that Hussman said he would recognize -- the ECRI WLI growth index turning positive -- has also come into existence for the last 3 weeks. I really don't see any wiggle room left. Under the terms he himself set, Hussman's recession index says we are in expansion."

 

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. Three weeks ago we shifted from bearish back to neutral. The last several weeks have been pretty close calls. The ratings have improved a bit.

[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

This is a light week for economic data.  We will start the week with news from the French elections, where Sarkozy is expected to lose.  This is widely projected to be negative for Europe and therefore for US stocks, but it should be reflected in markets by now.  The story will get continuing buzz, especially on Monday.  We will also have election results from Greece, where no majority winner is expected.

There are a number of minor reports early in the week, but I am interested in trade data, jobless claims, and Bernanke's speech on Thursday.  On Friday we'll have the Michigan sentiment index and PPI.  We could see a surprise from either.

We will also have some news from Omaha and the Facebook IPO where Cody Willard sees $100 B as an important dividing line.

Trading Time Frame

We mostly out of the market until late in the week for trading accounts.  Felix likes the current dip, so we are back in the market. The Felix forecast is for a three-week horizon, so it is best not to judge too quickly.  We have long experience with this program, which does not try to call market tops and bottoms.

If Felix is wrong, it will be back to the penalty box.  For now, we are looking for rebounds in several sectors.

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.  We seem to have another buying opportunity -- especially in tech and cyclical stocks.

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. This has been meeting objectives in spite of the market twists and turns.

Thursday and Friday were excellent days for finding new positions for this system.

Final Thoughts on Politics, Headlines, and Fear

In principle, investors know that the right time to buy is when others are fearful.  In practice, they join in the fear.

Bill Luby, in a nice guest column for Barron's, Be Greedy While Others Are Fearful, writes as follows:

"Fear is good business on Wall Street. For starters, fear helps to encourage impulsive and emotional decisions on the part of retail and institutional investors alike. It is contagious, capable of spreading extremely quickly and can sometimes appear to be unbounded. 

Fear also has been responsible for the development of a wide range of structured products tailored for institutional investors who wish to protect principal, minimize volatility and take other steps to counteract potential risks. The ugly side of fear is that it impels many people to sell at the bottom and wait to get long until markets are near a top. 

These are all good reasons to want to sell fear, but not why I choose to do so.  No, I am short fear because fear is almost always overpriced – and by a large margin."

Successful investing is not reckless, but it is fearless.  To achieve this requires a system and confidence in that system.  I recommend the following:

• Ignore the political noise and spinning.
• Note the low level of financial stress -- the European systemic failure is off the table.
• Note the low recession odds from the best sources.
• Observe the continuing growth in corporate earnings, and the low forward multiple.

These are all encouraging conditions for long-term investment.  Even conservative investors can own some dividend stocks and sell calls against them.

This is what the market is giving us, and we should take it.

[long AAPL]

The American Voter: Often wrong but never in doubt!

Let me start with a proposal about politics that would get wide agreement:

The 2012 election will be significant for the economy and the financial markets.

Getting a handle on this requires understanding the nature of the American Voter -- a special breed. The long series of election studies shows that voters have strong opinions but often lack information.

The latest story on this line cited a Pew Poll asking people a simple question: Who is the Chief Justice of the US Supreme Court?

If you know the asnwer, put yourself in the top 25% of the population. I understand that most people might not know, but some responses are amazing. 8% said "Thurgood Marshall" proving that they had heard of this famous Justice and former Solicitor General. They did not seem to know that he had never been the Chief Justice nor that he died in 1993. 4% cited Harry Reid! A little confusion of the branches of government.

A few years ago I reported that 80% of the people could name two of the Seven Dwarfs, but only 30% could name two Supreme Court justices. Who do you think is the best-known Justice?

Background

As a former poli sci prof, I have studied every presidential election since Truman in 1948. As an undergrad student, I did an analysis of voting data on the Kennedy/Nixon debates in 1960. When I started in the financial markets in the late 80's I looked to the analysis of politics as something that would provide an investment edge -- and it has.

I do not engage in political advocacy at "A Dash." I am a political agnostic when it comes to investing -- seeking to profit no matter who is in power. I have opinions that I share with friends and express in the voting booth.

Here in Illinois we have our own system of term limits for politicians: One term in office and one in prison! I have voted for officials from both parties.

I am trying to put this expertise to work, but the crystal ball is still cloudy for this year.

The 2012 Election

I have not yet suggested investment conclusions for this year, but it is an active research project. It was only last week when we learned, for sure, the GOP nominee -- my prediction in my January year-ahead interviews. We can now start analyzing the actual policy differences, as opposed to the skirmishes we are already seeing this week.

Each week will provide some additional clarity, but there is a problem.

The most important issues for investors require significant knowledge and analytical skill. The most salient issues for voters are things that anyone can understand.

We can see this taking shape.

Investor issues include the following:

• Economic growth -- stimulus, the Fed, and deficits.
• Regulation -- more or less. Big business or small.
• Health care -- how much and how to deliver.
• Supreme Court Appointments -- judicial philosophy and policy dispositions.
• Foreign policy -- leadership, peacemaking, diplomacy, and command skill.

and we are just getting started.

Things of interest for the electorate include the following:

• Treatment of pets no matter how long ago. (LBJ caused a controversy in playing with his dogs, "Him" and "Her" by lifting one by the ears -- picture below).
• What someone in the campaign said about the role of mothers and work.
• How quickly we should fire misbehaving government officials.
• Whether the leader ever changed his mind about something.

Notice the difference in the knowledge and skill required. The latter list of topics is something where everyone can have an opinion with little information. The opinion is based upon everyday experience. Yours is as good as mine.

Investment Conclusion

The big issues will eventually be important, but I do not see it so far. At the moment we just have a spectator sport. There is no reason to jump the gun with investment picks.

 

 

Do You Adjust Your Price Targets?

I hate static price targets!  Hate them!

Most of the research we read or see on TV is a bureaucratized and sanitized version of analysis.  The firm determines something, and that is the official version for public consumption.  Those who pay no attention to changing conditions add no value for investors.

Did you notice that things are better in Europe?  That economic data have improved?

If not, perhaps you have the wrong approach to your research.  You need to be flexible, responding to new information.  Most of those who claim success at market timing are exaggerating.  If you missed this prior article that showed how to check track records, please take a look.

Examples:

A big-time firm sets a price target for a stock.  The stock rallies and hits the target.  Then they move the target up by 20%.  How helpful is that?

Suppose it goes the other way.  The stock sells off and the firm lowers the target while retaining a "buy" rating.  How helpful is that?

This is why I do not follow analyst price targets for stocks.  I review their research and I draw my own conclusions.  I revise my price targets each week.  I review my most recent expectations for corporate earnings and cash flow and compare this to the current price, the market multiple for similar stocks, the multiple for the overall market, and the return from alternative investments.

Isn't that what you would do if you took the time?

I described the flawed process of big firms in this article from 2010.  By contrast, I described my own approach for our Great Stocks program:

"Analyst reports can be very helpful.  There is a lot of information about the business model, recent trends, and risk factors.  Reading several reports can help in identifying the consensus, especially what the analyst community is worried about.  Knowing these concerns can help you anticipate upgrades and downgrades.

I use the raw data to set my own target prices, and I review the targets frequently.  I select stocks with a target that is at least 25% higher and with attention to near-term catalysts and risks.  I have found that this is a good level for a goal, understanding that it will be achieved only some of the time.  Trying for home runs is tempting, but not as effective.

I almost never own a stock at the time it hits a target.  This may seem strange, but consider two cases:

1. If the stock makes a big move, but the fundamentals have not changed, it no longer has the potential for an additional 25% gain over the next twelve months.  I sell and move on to something that meets my criteria.  I sell these stocks before the target is reached.
2. If the stock makes a big move and the fundamentals keep pace, the target is moving as rapidly as the stock price.  This enables me to hold stocks like Apple."

Current Investment Implications

As the first quarter of 2012 draws to a close, there is a fierce competition to call the market top.  I watch the entire spectrum of opinion closely.  At the risk of oversimplifying, I will suggest two broad viewpoints:

Those with a static market target.  These observers started the year with an idea and they will not be budged!  Members of this group share some or all of the following characteristics:

• Using prices from ten years ago to determine current market values;
• Excessive fixation on calendar effects;
• Excessive attention to the length of past market cycles;
• Substituting fake data (what they personally believe interest rates SHOULD be, what they think profit margins SHOULD be, using the discredited Shadow Stats, complaining about seasonal adjustments, and making other assorted excuses);
• Over-emphasis on debt and austerity;  and most importantly....
• Embracing a political viewpoint that excuses all other analytical mistakes.

Those who remain flexible.  These observers are watchful and wary, but open to new data.  Members of this group share some or all of the following characteristics:

• Monitoring earnings expectations as the best guide for future stock prices;
• Using long-term data as the basis for establishing earnings growth and profit margins;
• Understanding that there is no set time for a market cycle.  A deep recession may take a longer recovery period.  We might only be in the third inning of the recovery.
• Accepting the reality of new data.  No Excuses!  No changing of methods.  No rejection of seasonal adjustments after always using them in the past.  Not starting with a pre-conception and ignoring contrary evidence;
• Recognizing progress.  If a few months ago you thought that there was systemic risk from Europe and there would be a deep recession there, did you modify  your market viewpoint when this did not happen?  The successful investor constantly adjusts for risk, using indicators like the St. Louis Financial Stress Index;
• Ignoring politics.  This is true whichever party is in power.  It is part of the electoral process for the "outs" to disparage any signs of progress.  If you want to succeed as an investor, you learn to ignore this background noise.

Conclusion and Current Ideas

The two profiles provide a sharp contrast.  Which fits your own approach?

There are many stocks that are attractive despite higher prices?  Why?  The earnings potential has grown faster than the price, and the risk is lower.

Some stocks that I see in this group are Oracle (ORCL), Apple (AAPL), JP Morgan Chase (JPM) and Caterpillar (CAT).  These are a few illustrations, but there are many other tech stocks, deep cyclicals, financials, and health care names that are worth consideration.