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Date: Sunday, 01 Jun 2014 04:24

Do you have an opinion about stocks or bonds or foreign exchange? If so, it is easy to find a market message that will support (or contradict) your viewpoint.

The "message" of the market has rarely been this confused. With plenty of important news and data this week, the theme will be: Can we find clarity in the market message?

Prior Theme Recap
Last week I expected a focus on housing. The short trading week would start with Prof. Shiller (that was right) and end with discussion of pending home sales (also right). In between, there was plenty of filler because nothing much seemed to be happening. I lost count of the number of stories about the driverless Google car – interesting, but not very relevant for the markets.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think. Feel free to suggest your own likely theme in the comments.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

What is the "message" of the market? Will it be clarified this week?

Here are three perspectives, from three different markets:

  1. Stocks are at new highs. Historically, stocks have been a leading indicator for the economy, reflecting expectations about future earnings.
  2. Bonds are rallying. Many view this as a sign of economic weakness. Those who are bearish on the economy like to insist that the bond market is "smarter" than that for stocks. Santelli watchers get this viewpoint every day. Cullen Roche offers some alternative concepts. I analyzed several explanations two weeks ago in this WTWA post.
  3. The VIX (the volatility index) is making fresh lows. Most pundits argue that this demonstrates unwarranted complacency. It is a warning to equity investors. (See a good argument at Free exchange. See also Cam Hui for a more nuanced interpretation).

The market message is confused and inconsistent!

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.

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

There was plenty of encouraging news.

  • Consumer confidence improved. This is the Conference Board version. It usually tracks with Michigan, but not always. Doug Short has good analysis and charts.
  • Chicago PMI was very strong at 65.5. This is the best read on the national ISM manufacturing report. It gets more attention when there is a weekend before the national report. It is good news, but we'll know a lot more on Monday.
  • Case-Shiller home prices beat expectations rising 1.2%.
  • Capital spending should improve. Even bearish economists note the importance of capital spending. Dr. Ed Yardeni explains the relationship with forward earnings, which continue to improve.

  • Initial jobless claims improved dramatically. This is a noisy series, but one of the best concurrent economic indicators. It helps us to understand the number of job losses, but we still need to learn about new job creation.
  • Durable goods orders were strong, up 0.8% seasonally adjusted and even stronger on non-adjusted data. Steven Hansen at GEI has complete analysis and charts, including this one:

The Bad

There was a fair share of bad news last week.

  • Sentiment is more bullish. This is a contrarian indicator. Bespoke tracks the American Association of Individual Investors series. Their typically fine chart shows the current gain, the biggest jump in more than a month. They also note that it is not yet at the average for the entire bull market – 38.4%

 

  • Personal spending declined by 0.1% in April. Personal income growth was acceptable at 0.3% (Calculated Risk).
  • Michigan sentiment disappointed with a final May reading of 81.9. I view this series as important (and not just because I am a Michigan man). My own research shows it to be a good indicator of spending and employment. Doug Short does a regular update of the series which includes my favorite chart. You can find it here.
  • Pending home sales disappointed, with growth of only 0.4%. Sober Look argues that lower mortgage rates will not help. Bonddad remains bearish.
  • GDP declined 1% in the first quarter of 2014. I am scoring this as "bad news" since it was a significant downward revision and GDP is the final measure of economic performance. In fact, the market shrugged off the news. Dan Gross notes the inventory effect (accounting for the entire revision). Personal consumption increased 3.3% and durable goods increased 1.4% despite weather effects. (Hale Stewart). Prof. James Hamilton provides an even-handed take. He notes the weather and the consumption increase, but also observes that part of the spending increase was on health care. Business fixed investment and new home construction declined. "I am still expecting numbers for the rest of the year to come in much better. But there's no getting around the fact that 2014 got off to a pretty weak start."

    One way of view the data is in terms of real GDP per capita. This method is recommended by my Scutify jousting colleague Simon Constable in his award-winning book on economic indicators – an excellent reference. (Curiously, I act more like a consumer of data while Simon claims an advantage over the economists he covers as a journalist. Maybe we should switch jobs!) Doug Short does a regular update of GDP in these terms. His fine chart (one of many good ones) shows the sad story of continuing disappointment in the US economy. (Doug's charts should be classroom examples for those trying to explain data – log scale when appropriate, helpful trend lines, accurate sourcing, good description, multiple variables all clearly included, and helpful callouts.)

     

 

The Ugly

Detroit rebuilding costs. Knocking down abandoned property is an inevitable part of fighting blight in a city that has gone from a population of 1,850,000 in 1950 to 700,000 last year. The abandoned homes will never be used again. Even destroying those leaves problems of lead and asbestos abatement. The cost estimate is $850 million. Fewer than half of property owners pay taxes. 118,000 properties are on track for tax foreclosure, but who will buy them?

There are no easy solutions.

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 Paul Kasriel (via GEI), who shows the error in knee-jerk analyses of the unemployment rate. He writes that everyone has been trained to do a quick comparison of labor force participation with unemployment to see if the rate is providing a clear message. This is not enough. He writes as follows:

… (A) decline in the labor force does not always reflect an increase in so-called discouraged workers. And, in fact – well, fact may be too strong a word, but according to data contained in the April Household Employment Survey – the number of people not in the labor force in April but who did want a job changed by a big fat ZERO.

This is something to watch for on Friday.

 

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.


Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug also has the best continuing update of the most important factors to the NBER when they analyze recessions. In general, you need to have a business cycle peak and then a significant decline. In contrast with Bob Dieli's method, this approach shows a possible peak in some of the elements.

 

The Week Ahead

We have plenty of data this week including the most important reports. The WSJ focus on the big news is helpful – a useful alternative to the comprehensive list.

The "A List" includes the following:

  • Employment report (F). Rightly or wrongly, this remains the most important data for the market.
  • ISM index (M). A sensitive gauge of manufacturing trends with some leading components.
  • ECB policy decision (Th). Important not only for forex, but for stocks and bonds as well. Here is a guide about what to watch. And also here.
  • Initial jobless claims (Th). Best concurrent read on employment.

The "B List" includes the following:

  • ISM services (W). More businesses covered than manufacturing, but a shorter history for the series.
  • ADP employment (W). This measure of private employment deserves respect, and gets it from most Street economists.
  • Auto sales (T). Good read on possible consumer rebound. Watch the F150 indicator of construction activity.
  • Beige book. (W). This is the "color" provided to FOMC participants at the next meeting – anecdotal evidence from each Fed district. Will it confirm the official interpretation of data?
  • Construction spending (M). April data, but an important sector.
  • Factory orders (T). More April data.
  • Trade balance (T). April data, but relevant for Q2 GDP, which will be a subject of great interest.

There will be plenty of FedSpeak and also news from the G-7 Summit in Brussels.

 

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix is a bit more upbeat this week. There are more fresh buys in the ETF universe, including QQQ. The high penalty box level implies less than normal confidence in the ratings. We briefly cut our trading position size during the week, but finished the week fully invested in three top ETF sectors.

The overall call is very close between bullish and neutral. Even in a neutral market there are often good sectors to buy.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

The market did not provide much opportunity for fresh buys. The gentle upward action is fine for long-term investors and excellent for those trying out our Enhanced Yield approach.

Here are some key themes and the best investment posts we saw last week:

Doom and gloom sells – like sex, writes Howard Gold at MarketWatch. He is keeping score at taking names! This is so much better than the TV folks who pander to viewers by trotting out these pundits without any reference to past record. He writes:

It draws viewers to TV, eyeballs to websites and buyers to books from "Crisis Investing," published in 1980, to "Surviving the Great Depression of 1990" to "The Collapse of the Dollar and How to Profit from It" (2008).

The financial crisis and Great Recession created a bull market in doom and gloom. But nearly six years after Lehman Brothers' collapse, the worst hasn't happened — unless you consider a 180% advance in the S&P 500 Index a disaster. Which it was, to those who avoided U.S. stocks because they believed the doom-and-gloomers.

So, now, enough time has passed to label certain outrageous forecasts as just plain wrong and to call out the people who made them.

Here are the four worst predictions to gain traction over the past few years.

Regular readers might want to guess before reading!

Could there be a "stealth recovery" in the economy? The analysis from HighTower Advisors includes this interesting quotation from Richard Bernstein:

Bear markets are made of tight liquidity, significantly deteriorating fundamentals, and investor euphoria.  Although the Fed is starting to reverse course, there are no signs yet of a significant tightening of liquidity.  Rather, the data are beginning to suggest that private sector credit growth is starting to replace the Fed as the provider of liquidity

Sell in May did not work. (WSJ). Serial correction forecasters will insist that it is now "Sell in June" or something else. The reality, an answer to my client questions nearly every week:

  1. There will be a market correction of 15-20%. Look at a long-term chart. It is a regular event.
  2. You cannot predict when these will occur and neither can the supposed experts. If you get good evidence on their market timing records, you will see. Check out my post on the Seduction of Market Timing.
  3. Those trying to time this correction have already missed a big move. Ironically, this does not convince them of a mistake. Instead, they are even more determined to wait.
  4. A better approach is to watch the fundamental indicators (recession odds and financial stress) and quit trying to time the smaller swings.

You pay too much attention to financial news. Morgan Housel describes this so well! Here is the daily story:

NEW YORK – S&P 500 companies earned $2.71 billion of net income on Tuesday. $890 million of that will be paid out as dividends, with the remainder retained for future growth.

That's it. The report would be the same tomorrow, the next day, and the next. Figures would be updated quarterly, but the format wouldn't change, ever.

This would not be very good for ratings, but it would help your bottom line.

Take advantage of pessimism writes Scott Minerd of Guggenheim partners. After noting the recurring prophesies of doom, he suggests that central banks remain active on the other side. He writes as follows, providing a helpful chart as well:

U.S. and European economic data have been on an improving trend, helping to bolster the outlook for the global economy. As output accelerates in advanced economies, countries around the world should benefit from increasing demand for manufacturing inputs. With the investment cycle turning in the United States and Europe, global trade should accelerate in the near term, helping kick-start growth in some struggling emerging market economies.

 

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

The very concept of the market message should be troubling for active investors. If you think that markets are efficient, you are wasting time trying to gain an advantage. If you deny the efficient market hypothesis, what is the point in searching for a message?

Most cite the market message when it supports their viewpoint and ignore it otherwise.

I recommend that you reach your own conclusions based upon fundamental data. Since my indicators show an improving economy and little recession risk, I interpret the strength in bonds as a reflection of other factors – low inflation expectations, favorable comparisons to European yields, and traders caught "offside" on the bond trade. (I sympathize with that!)

To the extent that the message is inconsistent, I expect yields to rise over the remainder of the year. I do not see "complacency" in the stock market. It is better described as an uneasy balance of nervous viewpoints on both sides.

And by the way….so many treat the VIX as an indicator rather than a market. That is an error. If you really believe that the VIX signals complacency you can step right up and buy options on the underlying stocks or else the VIX itself.

Why would anyone think that the options market is less sophisticated than that for stocks or bonds?

Author: "oldprof"
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Date: Sunday, 25 May 2014 08:23

In a holiday-shortened week, there is plenty of data. The Case-Shiller home-price index will set the tone on Tuesday morning. After last week's soft housing reports, many will be asking, Will housing weakness undermine economic growth?

Prior Theme Recap
Last week I expected a focus on bonds versus stocks. It was a light week for data and the bond market rally was an ongoing mystery. That theme was as good as any, but nothing really stood out. The appetite for content created many "fluff" pieces and trading was very quiet.

As long as you did not take small moves seriously, there was an opportunity to do some buying at mid-week.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

Has the housing recovery stalled out? If so, what does it mean for the economy?

Here are some perspectives:

  • Housing is a leading component. It is not responding to interest rates as expected, and those good times may be ending. (New Deal Democrat).
  • Nearly ten million Americans have underwater mortgages. These are concentrated in low-priced homes (30%). Some of the least expensive homes were purchased by investors and are now rental properties. This leads to poor prospects for entry-level buyers and also interferes with those wanting to "move up." Many others lack real equity that allows them to trade up or trade to move to a new job. (Various accounts of the Zillow story. See Erin Carlyle of Forbes).
  • Home affordability is challenging, especially given sluggish income growth. (MarketWatch).
  • Big investors are betting against housing. Bill Miller disagrees. (MarketWatch).
  • Expect sideways movement and gradual progress. (Calculated Risk).

It all seems pretty negative.

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.

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

There was little news, but it was mostly good.

  • Car sales are looking strong, up seven percent according to private research firms in a strong spring selling season.
  • Forward earnings estimates rose for the sixth consecutive week. (Via Brian Gilmartin).
  • Leading economic indicators rose 0.4%, beating expectations. Doug Short has a complete analysis. This chart (typical of his skill in bringing data to life) tells the story:

  • New home sales beat expectations, but this is a noisy series. I am scoring this as "good" on the monthly improvement and the market reaction, but it is a close call. Calculated Risk notes that the first four months of 2014 are down 2.6% from last year. John Lounsbury and Steven Hansen reach a similar conclusion, after viewing the data in various ways.

The Bad

There was a little bad news as well.

  • Immigration reform is stalled again. Nearly all of the economic studies show the benefit of more immigration and also reassure that immigrant labor is a complement to native-born workers. This explanation is from a liberal source, but many conservative leaders (former Speaker Dennis Hastert, for example) take a similar position. This is one of many economic issues that has become politicized.
  • Jobless claims increased by 28K, worse than expectations.
  • Existing home sales missed growth expectations.
  • Tensions between Russia and Ukraine remain high. Mark Mobius of Franklin Templeton Investments discusses the sanctions and the economic effects.

 

The Ugly

Penny stocks, a market that is once again seeing a lot of action. (Via WSJ). The SEC is acting against the worst frauds. Cody Willard often warns investors at Scutify.com about these dangers (especially in pot stocks), harkening back to his excellent 2011 article.

The Humorous

If you missed the video interviews with NYU grads about Janet Yellen's commencement speech, take a minute for a few chuckles. While some have a general idea of who she is, others were wondering and would have preferred a different choice. (Tina Fey?)

 

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. Last week there was no award. This week I have two great candidates. I'll save one for our next installment.

This week's award goes to Barry Ritholtz for The Truth About Auto Sales and also Jalopnik on the same theme. When things get a little slow on the bad news front, some sources are happy to recycle old stories as if they were current. I wonder how many readers looked carefully at the pictures of the cars.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.


Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

Blaine Rollins at 361 Capital always has some interesting ideas, with good charts and data. This week he cites an analysis from JP Morgan comparing current conditions to past market peaks – quite different!


The Week Ahead

We have a lot of data stuffed into a short week. Here is what to watch for.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on employment.
  • Michigan sentiment (F). Information on spending and employment that you cannot get elsewhere.
  • Personal income and spending (F). April data. Important read on the consumer and the economy.
  • Durable goods (T). April data, but a component for GDP.

The "B List" includes the following:

  • PCE prices (F). This is the inflation indicator the Fed watches. Whether or not you agree with this choice, you should pay attention.
  • Pending home sales (Th). All things housing are of great interest.
  • Chicago PMI (F). I do not place much emphasis on regional results, but this one is a good predictor of the national ISM index – a major indicator. I am especially interested when a weekend separates the two releases.
  • GDP second estimate. Everyone knows this will be very weak, possibly a decline of 0.5%. As usual with GDP releases, we are so far into the next quarter that interest will be modest. It does provide the baseline, showing how weak things were at the start of the year.
  • Case-Shiller home prices (T). This index has the brand name value, but is actually a bit slower to pick up changes. Expect the Professor to do some interviews with a worried look and a cautious take!

Ukraine remains a wild card. There will be a little FedSpeak but also possible hints about ECB policy from a European conference. Negative rates in store? I don't care much about the regional Fed surveys.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has lost enthusiasm for the market. Few choices in our ETF universe qualified as fresh buys. (We use a rating of 20 or higher and exclude sectors in the penalty box). The broad market ETFs look a little worse than last week. The overall picture is neutral – with the Q's (QQQ) slightly positive and the Russell 2000 (IWM) slightly negative. We are still fully invested for Felix trading accounts, but the ratings are marginal holds. We will probably have reduced positions and might even be completely out by next week unless there is some improvement.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

We had enough volatility to do some additional buying, replacing some enhanced yield positions lost at options expiration.

Those trying out our Enhanced Yield approach should have enjoyed yet another good week in a sideways market. Bespoke illustrates this in the current market:

The time decay in last week's slow trading was dramatic but rather predictable. It is always satisfying to make money when nothing is happening. To do so it is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it. This week on Scutify I responded to a reader question about IBM. I explained that I traded it versus the JUN 190 calls. This has been a rinse, lather, repeat position for us. The stock does not seem explosive to the upside. We have collected dividends and call premiums and played the trading range. Today the stock moved a little higher while the calls actually declined in anticipation of the long weekend. You won't read that in any book about option deltas!

Here are some key themes and the best investment posts we saw last week:

Summer melt-up? I am not necessarily predicting this, but we all need some balance in our reading. It seems like the pundits and the media are very negative. The emphasis on top-calling makes the risk/reward seem out of balance. The source expects a final surge and then does the obligatory crash prediction. Sheesh! (BAML via Business Insider).

Time to avoid small caps? The noisy sources emphasize the dire implications of the small cap weakness. Our programs hold these stocks only in our "Aggressive Program" and even then in small allocations. The entire Russell 2000 is equal to about six stocks in the S&P 500. There is big reward, but also big risk. If you are worried about risk, choose larger stocks. Here is a nice analysis showing the distinction between small and mid-caps.

Be careful with ETF choices and trading. Many investors treat ETFs as a cheap substitute for mutual funds with the advantage of more liquidity. There are some problems with that liquidity. Sometimes the ETF holds illiquid holdings, preventing a fair settlement price. On other occasions there are too many sellers hitting the exits at the same time. I regularly trade in ETFs and I am not warning against the entire asset class. You just need to use caution in your choices and trade timing. Tracy Alloway at the FT has a good post on the subject.

Watch out for slick salesmen selling yield. Josh Brown already warned you about brokers and incentives in his excellent book, which I reviewed here). Josh knows the pitch and shares it with the authenticity of an insider. This time he flips it with a conversation you will NEVER hear. I cannot do justice to this with a quote, so you need to read the entire post. Conclusion: Someone selling you an amazing yield is probably exaggerating and collecting a big fee. Maybe you suspected that…

Want to know the most popular stocks owned by big hedge funds? They must reveal the holdings and you can see the list in this article by Steven Russolillo of the WSJ. Pretend that you are playing Family Feud and try to guess stocks from the top 5. Answer at the end of the post.

Barry Ritholtz seems to have a new great theme each week in his BloombergView column. This time he discusses risk, using odds of death to provide an out-of-the box challenge to investors. We all over-estimate the odds of dying from terrorism rather than mundane causes like heart disease. The same story is true for investors who exaggerate the odds of market crashes. Read the entire post.

Leon Cooperman, Chairman and CEO of Omega Advisors spoke at Columbia Business School. His chart-packed presentation illustrated the improved financial situation for both households and businesses, as well as catalysts for near-term action. Here is one of the many good charts, leading to his conclusion that "treasuries and corporate bonds are uninteresting and unattractive."

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

I was surprised at the traction from the Zillow story about underwater mortgages. Everyone's focus was on the 18.8% rate with little comment that this is much better than the 31.4% rate from only two years ago.

The stories also characterize the market in terms of simple stereotypes. This makes for a compelling story, but it is not good economic analysis. Markets actually reflect a distribution of participants with different price points and motives,

A real economic study would take note of a few factors:

  • If 30% of low-cost homes are underwater, then 70% are not. It reduces the supply, but does not end it.
  • Many homes are still purchased without 20% down via mortgage insurance.
  • If low-cost existing homes are in short supply, builders can provide new ones. (And they are).
  • If there is real demand for low-cost homes, those purchased for investments can be offered for sale.

To summarize, if you view housing as a market instead of a few stereotypes it is easier to see how some progress could be possible, progress that includes new construction. Economic growth would be better if we simply had some relief from the housing "drag" of the last several years.

Top Hedge Fund Stocks

Top five include Google (GOOG), Apple (AAPL), General Motors (GM), American International Group (AIG), and Time Warner Cable (TWC). How many did you guess? How many do you own?

Author: "oldprof"
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Date: Friday, 23 May 2014 01:51

The insightful investor develops solid indicators and then follows the data.

This may seem obvious, but instead….

Many pundits start with the conclusion and then search for evidence.

 

[For complete appreciation of today's post, follow the links for the relevant music.]

There are a number of interesting current examples. In various prior posts I have suggested that these were not really important leading indicators, so I am not flip-flopping by drawing inferences from improved conditions. Others will do that via their silence. I suggest that you recall the scary recent warnings on these themes – now all showing improvement – and note the sound of silence:

 

  1. Margin debt. Remember how you were supposed to be scared witless (TM OldProf) by this event? It appeared at the same time as prior market tops. There was no evidence that it reflected borrowing for long trades rather than short ones. There was no evidence that it was a leading indicator. Those who scared you with these charts are not likely to inform you that margin debt has declined. (See WSJ).
  2. Divergences. Remember how this signaled that the market was about to crash? Before that the small cap rally was frothy. Today's market action put the Bomp back into biotech and the small caps. This means that the worrisome divergences (shown as not so worrisome here) have been reduced. This means that some will revert to the "frothy" argument while most of us should just ignore the whole matter.
  3. Sentiment. Remember when you saw weekly chart updates on how bullish sentiment was. That was a contrarian indicator since it supposedly showed that no one was left to buy. This was always a stupid uninformed argument since data consistently showed that most investors were 50% in cash – scared witless. I wrote about this a year ago, and the post is worth revisiting. It explains why you should focus on fundamentals of risk and reward.

This list could be longer and suggestions are most welcome. There are always market worries (remember the "cockroach theory" about Europe? The Cyprus "crisis"? How a single small country (Belarus) was going to destroy the European recovery by voting against a reform? The insightful investor embraces the opportunity presented. (More detail on the concept in this post, which some have graciously suggested was my most helpful. At the time I wrote this, many commenters thought I was crazy).

A Fearless Forecast

As you read your investment news tomorrow you will not hear about the positive changes noted above. Expect instead to see the stories shift to some new source of concern, something that will generate advertising revenue. One of the Tyler Durdens will find a new omen or something to worry about. And of course there are the reliable mainstays of bashing the Fed about money printing and how it will all end badly. It is time for someone to develop an algorithm on that one, since it reliably shows a lack of anything meaningful for pundits to discuss!

If you really want to achieve investment success, you need a forward-looking approach you need to "See Clearly Now."

Author: "oldprof"
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Date: Sunday, 18 May 2014 04:02

To the surprise of most, bonds have rallied while stocks have move sideways. In a week with very little data, and many thinking about an early Memorial Day vacation, the bond/stock tradeoff to be a favorite topic for the punditry.

Prior Theme Recap
Last week I expected a focus on market divergences, especially the decline of small cap stocks. While the financial media also featured news from hedge fund gurus and Fed speakers, the divergence notion was an important theme all week. It will probably continue.

Since I do not regard these divergences as an important leading indicator, the planning was helpful in doing some shopping.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

What should we make of the rally in bonds, a surprise to nearly everyone? Does it provide an important signal of weakness in stocks?

It is a complex topic, with many angles.

  • It was the contrarian reaction. Ryan Detrick made a timely call using this reasoning. He expects a continued drop in yield. Check out his reasoning!
  • The Fed is on a long-term low-rate policy. While this directly affects the short end, it also alters the term structure and therefore the long end. Ben Bernanke has been tipping this to those attending his $250K sessions. (Also here).
  • Short covering by everyone who was wrong. (Barron's)
  • Pension plans are locking in safe gains. (See Doug Kass via Josh Brown for this and other ideas)
  • The economy is weakening. For the "structural deflation" hypothesis, see here.
  • Prices are attractive compared to European bonds. (Gundlach).
  • There is less Treasury issuance. (Guggenheim).

For investors trying to make stock/bond asset allocations, the explanation is important. Past speculation (Woe is us! After QE ends, no one will buy US bonds!) has been unhelpful.

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.

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

There was little news, but it was mostly good.

  • Sea containers set another record for growth in April. This is a good trade indicator. See Steven Hansen's comprehensive analysis and charts at GEI.
  • Small business optimism has improved. Dr. Ed Yardeni highlights the percentage of those citing "poor sales" and shows the correlation with the unemployment rate.

  • Rail traffic strength continues. This is true for all time frames, as Steven Hansen shows in a helpful analysis at GEI.
  • Weekly jobless claims hit a seven-year low. Bespoke has a good post and several helpful charts, including this one:

  • Looser rules for mortgage lending. (Via WSJ). While some will decry this as subprime 2.0, our scoring is based on whether something is market friendly. The initial impact of this will be positive for home construction and the economy.
  • Earnings guidance turned positive. For the last ten quarters – and despite the rally in stocks – a regular feature of earnings season has been a weaker outlook. While forward guidance is not strong, it is finally positive, as noted by Bespoke.

  • Japan's economy is perking up. The Q1 rate was 5.9%, the best in three years.
  • Housing starts (and building permits) improved sharply. There is a contra argument since much of the increase is multi-family. Calculated Risk has some nuanced commentary and also the basic chart.

The Bad

There was also plenty of bad news.

  • Michigan sentiment was weak. The preliminary number is sometimes revised, and the market did not seem to have much reaction, but I take this seriously. This series provides good information on both consumption and the overall employment market. It is still far from the levels we expect in a robust economy. Doug Short has a full analysis, and my favorite chart of this series.
  • Tax withholding is lower. This is inconsistent with economic news about employment, so it is troubling. New Deal Democrat ponders possible reasons. Taxpayers claiming more exemptions? This is worth watching.
  • Retail sales disappointed. The 0.1% gain was short of 0.4% expectations. Regular readers know that I do not like excuses, but I also take note of unusual circumstances. When you had census worker hiring, it affected employment. When the government instituted "cash for clunkers" there was a distortion in car buying. This is reality. This year there are some weather effects that are not captured with the seasonal adjustments. Some stores seem to have been affected more than others. First Trust argues that the late Easter shifted some sales. Weekly data from Johnson Redbook (here and here) have been better. I am scoring this as bad news, but watching carefully.
  • Industrial production declined. The 0.4% decrease is not consistent with current economic growth. Once again we have an unusual weather effect. The prior month reflected an increase in utility production (cold weather) which has now been reversed. That is not the whole story, but it is something to keep in mind. Note the effect on the Big Four indicators in the Quant corner chart below.

 

The Ugly

The drought, now affecting half of the US with 15% experiencing extreme conditions. Vox has a great article and charts, including this one:

 

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. No award this week. Reader nominations are always appreciated!

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.


Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. He notes that the ECRI has emerged from hibernation. "Interestingly, the interview includes no reference to ECRI's recession call, instead focusing on whether the winter economic downturn was weather-related or reflective of a cyclical downturn."

With Q1 weakness in the economy, it is important to monitor Doug's Big Four indicators. There is clearly some weakness, analyzed in detail in the full post.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

One of his key charts illustrates where we are in the business cycle – crucial for the long-term investor. Here is his most recent chart:


   

   

The Week Ahead

We have a very light week for news and data.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on employment.
  • New home sales (F). Important as a concurrent read on the economy and also a leading indicator for future employment and consumption.

The "B List" includes the following:

  • FOMC Minutes (W).  Unlikely to produce fresh news, but that won't stop the punditry.
  • Existing home sales (Th). Important concurrent read on a significant economic element.

There are more regional Fed surveys. I do not regard these as very important (at least not individually) and it takes a big move in one for any real market impact. It is another active week for FedSpeak, including more from Chair Yellen.

Ukraine remains a wild card. I am not expecting much excitement from European elections either (preview here).

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued the bullish rating, and the choices have become more aggressive. The broad market ETFs look a little worse than last week. IWM (The Russell 2000), which is now negative. Wither fewer sectors in the penalty box, we have higher confidence in the ratings.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

We finally had enough volatility to do some buying – two down days in a row.

Those trying out our Enhanced Yield approach should have enjoyed yet another good week in a sideways market. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it.

Here are some key themes and the best investment posts we saw last week

David Merkel warns about risk and reward in his post, Playing for Pennies, Risking Dollars. He says the following about junk bonds:

I try to avoid investments where the upside is limited, but the downside is unlimited.  That's the way I feel about junk bonds now.  Have junk yields been lower before?  No, we have eclipsed the time in 2013 when the junk market was in a yield frenzy, until Bernanke uttered the word "taper."

I think he is too conservative about stocks, which have similar risk to the junk bonds but much more upside, but read his entire post.

Bubble talk? Since the bubble stories get the headlines, the average investor can easily be persuaded that current stock prices are an artifact of Fed policy. In truth, a combination of stronger corporate earnings, a better economy, and reduced financial stress fully justify the market rally.

Eddy Elfenbein, one of the best allies for the individual investor, updates his helpful earnings chart.

Scott Grannis looks directly at overall corporate profits with this chart:

Chuck Carnevale, whose F.A.S.T. graphs tool is an indispensable resource for investors, has ideas for you. In addition to illustrating how to use his approach, he provides ten stock ideas, each from a different sector. Great work, and worth reading the entire post carefully.

Beware of the micro-cap marijuana stocks. The SEC warns of misrepresentation of facts and market manipulation in some cases. Who could have guessed?

Hedge fund manager David Tepper has turned cautious. Jason Zweig reports his "nervous time" comment. This is interesting information for investors, who should always make sure to "right size" their risk. I warn that Warren Buffett's advice that stocks are better than bonds is not appropriate for all investors. The same is true of Tepper. You are unique.

Chuck Jaffe also has a great column on analyzing your personal risk/reward balance. You must be realistic. This is where I begin with each new client.

Stocks could be undervalued. Investors are bombarded with negative stories on valuation. Here is Jeff Saut with a standard metric (and not the only one) that you hear little about. He thinks it is "too optimistic" but worth noting:

If Graham and Dodd's estimated P/E formula is anywhere near the mark (P/E = 8.5 + 2x Growth Rate), the SPX's correct P/E should be 20.3, not the 16.6 times it is currently trading for on a trailing 12-month basis. Recall Graham observed the average no-growth stock traded at 8.5 times earnings, and that P/E ratios increased by twice the rate of earnings growth, therefore 8.5 + 2(5.9%) = a P/E ratio of 20.3, or a price objective of 2781 for the SPX.

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

The cause of the bond rally? There is no single reason. Most persuasive are the arguments about fund flows from Europe and conservative decisions by pension funds (finally closer to their targets).

Those inferring economic weakness include the usual collection of "bond guys" talking their book and assorted pundits who never seem to find the "buy" button for stocks. It is great fun to criticize economic forecasts, but most of the critics do even worse themselves.

Nearly everyone is just itching to call the "end of the cycle" because it has lasted a long time. I have been accurate in my patience. This was a prolonged economic cycle, featuring a slow recovery from a sharp decline. I recommend two key points to follow:

  1. A recession remains very unlikely in the near term – and that is the source of major market declines.
  2. The best economic forecasts remain solidly positive. If you prefer to follow some pop economist who did not actually take Econ 101, you should understand that he is seducing you with an image of reality and has no real track record. Contrast this with this take from one of our featured sources, Menzie Chinn at Econbrowser:
    1. Rebound in monthly GDP
    2. Continuing output gap of 3.2%
    3. No inflation concern

Most market pundits are not even thinking about what could happen if the output gap is closed.

Author: "oldprof"
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Date: Tuesday, 13 May 2014 15:37

How should traders and investors take advantage of seasonal patterns?

There are so many opportunities for dividing the calendar!  This year, the best has been to go long on Tuesday.  Here is the 2014 summary from the Bespoke Team:

avg daily change day of the week1

 

You could have done even better if you had sold short on the other days of the week.

Issues

You might well be skeptical about this easy system.  When I offered it for comment to the Scutify community they suggested that there were not enough cases and that it did not make sense.   Market veteran Robert Marcin suggested that this pattern would quickly be learned by the market.  Monday buying would anticipate the Tuesday effect, and it would quickly disappear.

In fact, prior years have had different days as the best performers.

So far, so good.  There have been eighteen Tuesdays to establish and test a pattern.

  1. There was no a priori hypothesis
  2. There is no “out of sample” data that could be used for a test
  3. The results are “data mining” covering a specific time period.

Those who are skeptical are fully justified.  The pattern broke down last week.

Implications

Let us take the conclusions and find a new setting.  How about the Presidential Election cycle.  This is getting a lot of buzz as “experts” opine about why the second year of the second term should be bad.  How many cases are there?  If you wanted to get 18  (the same number for this year’s Tuesdays), you would need to go back 144 years.  Would that really be relevant?

We have better data on the “Tuesday effect” than we have on the oft-touted Presidential Election Cycle.

Most of those discussing seasonality violate all three of the points listed above.

Challenge for the Seasonality Crowd

Why hasn’t the market “learned” this behavior and adjusted?

Did any of those parroting “sell in May” advise you to “buy in October” last year?

[Note to readers.  I have had several suggestions about improving the blogging platform, the graphic images, and the ability to deal with comments.  While people have expressed appreciation about the content, they have requested a better platform.  This is a "test post" on my new site.  Comments are very welcome.  Send to main at newarc dot com. Please bear with me as I work out the kinks.  Thanks!]

 

Author: "oldprof"
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Date: Tuesday, 13 May 2014 15:34

I am moving "A Dash" to a new platform.  I expect it to provide greater flexibility, better charts and images, and better handling of comments.

This is a difficult change after almost nine years at this address.  There will be some adjustment for me, but I hope readers will help out.

Please change your bookmark to the new site.

If you prefer the RSS feed or the email delivery, I am trying to figure out how to change these.  It is not easy, so you could speed things by signing up at the new site.

I might do a few posts at both locations.  Please let me know if you have any problems.

Thanks in advance for your patience and cooperation.

 

Jeff

Author: "oldprof"
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Date: Sunday, 11 May 2014 05:11

The latest bearish meme is the focus on market divergences. The idea is that a "healthy" market shows confirmation from various sectors. The Dow made a new record high this week, which does not really reflect the overall market. Many smaller stocks have experienced a significant decline from their highs.

In a week that will have fewer earnings stories and less important economic data, I expect many to ask, "Should we be worried about divergences?"

Prior Theme Recap

Last week I expected a focus on the Ukraine crisis. My main idea is that it is important for citizens but not really a market crisis. The muted impact from news last week provided some support for my thesis, although there were clearly some intra-day moves attributed to news from the region. The impact on Russian stocks is certainly important.

It proved not to be a primary theme, but the idea of fading this "news" is still sound.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

What is a divergence and should we worry about it?

Josh Brown cites Peter Boockvar who warns as follows:

You don't typically want to see large caps struggling at recent highs with less underlying participation by individual stocks – narrowing of participation at highs is how tops are formed. You also don't typically want to see new all-time highs for the S&P while the more economically sensitive small caps are in a correction. These things can resolve in either direction, but the historical bias is toward a resolution to the downside.

Josh, open-minded about the final resolution, illustrates the divergence between the Russell 2000 and the S&P 500 with this chart:

Is the divergence a cause for concern? Boockvar does not really provide any evidence about small caps being more economically sensitive, nor about how divergences are usually resolved. Here are some other viewpoints.

  • The average stock is already in a bear market. Sam Ro cites J.C. O'Hara, who echoes Boockvar's message about "masking internal weakness."

  • It is a rotation, emphasizing dividend stocks (see Bespoke).

  • It is a rotation, resulting from pension fund reallocation (via Cam Hui).
  • You see what you are looking for with trend lines. Greg Harmon has good charts and examples.

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.


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

There was little news, but it was mostly good.

  • ISM services increased to 55.2. That is the highest level in months. Read Doug Short's complete report for discussion of the underlying components and additional charts. Here is the headline series:

  • The quit rate is higher. There is some really bad analysis of the JOLTS report. Those who change their choice of indicator with the wind have thousands of choices. I emphasize the quit rate as the most important aspect of this report. It is not as good as other methods for analyzing overall job growth or unemployment. It is focused on turnover. The number of those voluntarily leaving their jobs is a good indicator of market health, and one that most do not know. 2.5 million people voluntarily quit jobs in February, the highest number since July, 2008. Nick Timiraos of the WSJ has a nice analysis with good charts. Here is the quit rate:

  • Initial jobless claims declined to 319K. This relieved some concern about the recent spike in this noisy, but important weekly series.
  • Hotels are on track for the strongest year since 2000. Calculated Risk reports the details – not surprising to this traveler!
  • Sentiment has turned bearish (a contrarian indicator). Bespoke has the story.

  • Earnings growth has been solid. 5.4% for Q1 and 8.36% on forward estimates. Earnings expert Brian Gilmartin has the full story. His insights have been very strong, both overall and on individual stocks.
  • Consumer credit continues to grow. This has been an economic and market positive for many years. (See Steven Hansen for an alternative viewpoint and details on the rate of growth).
  • A college education is worth $800,000. (From the SF Fed's Research) With plenty of recent emphasis on student loan debt, we should also keep in mind that education is an investment. Staying in school makes special sense when job markets are weak.

     

The Bad

There was also some bad news.

  • European deflation concerns. On one hand it is a positive that Eurozone countries can roll debt at low rates. (Remember the scary warnings from a couple of years ago?) We must also consider whether the reason is confidence or a different brand of fear. Ed Yardeni sees the plunging yields as deflation concern. Here is a key chart:

  • Productivity fell by 1.7% in the first quarter, the first drop in a year. The flip side is that unit labor costs were higher. The WSJ has a good account, evaluating the possible weather effects.
  • Continuing Ukraine effects are negative, even with the stalemate. Robert Kahn, of The Council on Foreign Relations, has a thoughtful analysis of the contagion from sanctions against Russia.

 

The Ugly

Drug shortages – not just specialized drugs, but generics as well.

The problem built for years, and Congress finally gave the FDA expanded powers to address shortages. The shortages averted have increased from 38 in 2010 to 170 in 2013, but the active number is still 300 per day. The extended article from Remapping Debate makes a proposal that we free-market types will question: Government manufacture and distribution of some drugs.

What is wrong with the market solution? Among various reasons, this one stands out:

…companies choose which drugs to manufacture based on projections for demand and, if they have competitors, what others may produce. Oftentimes, they prioritize newer generics with bigger profit margins, even if that increases the likelihood of shortages, according to a report released in February on the drug shortages by the Government Accountability Office. What's more, the watchdog agency said, older generics are routinely "discontinued in favor of producing newer drugs that are more profitable or that have more demand."

When older, less profitable generics are made, they're produced in limited quantities because unsold pharmaceuticals can't be stockpiled like bricks; they have a short shelf life. As HHS pointed out in its 2011 economic analysis: "There is little cost (except reputational) of producing too little of one drug (rather than another), but a potentially high cost of producing too much of that drug."

This is a truly ugly problem, and it is getting worse.

Housing Revisited

Following up on last week's data, we have more analysis of housing. Here are two interesting articles, both worth reading in full.

Logan Mohtashami, a senior loan officer, explains that prices are too high and there are not enough good jobs for strong new buying.

Calculated Risk has nine reasons to look on the bright side of housing, responding to many recent concerns.

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. Reader nominations are always appreciated! (Thanks to C.S. for this one).

In a world filled with two-variable "correlation charts" it is difficult for most to remain objective. Everyone knows, in theory, that correlation does not imply causation, but the stories sometimes sound so plausible. Tyler Vigen at Spurious Correlations has some good ones. (HT to Dina Spector at Business Insider, who highlights some favorites). Here is mine, showing per capita chicken consumption versus total US oil imports:

You might also enjoy this vintage "Dash" where I looked at Ben Bernanke, the balance sheet, and the S&P 500.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new system.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. He notes that the ECRI has emerged from hibernation. "Interestingly, the interview includes no reference to ECRI's recession call, instead focusing on whether the winter economic downturn was weather-related or reflective of a cyclical downturn."

Philosophical Economics has a provocative analysis about projected stock returns for the next ten years. Unlike some modelers who take hundreds of variables, all of the available data, and create a back-fitted regression equation, this is a simple bivariate approach. It is history, of course, so the reasoning is important. The article is long and thoughtful. I recommend it.

The basic conclusion is that the expected future return from stocks is inversely related to the average investor stock allocation. The resulting chart is compelling. It suggests an annualized 6% return over the next ten years.

How does this stack up against the other models that you always see quoted? Better, much better. Better than the "Buffett indicator," and much better than the Q-ratio or CAPE.

 

The Week Ahead

We will have a moderate week for news and data. Some sources are doing better with an approach similar to mine – not listing everything, but highlighting what is important. Kathleen Madigan at the WSJ has a nice take with five things to watch.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on employment.
  • Housing starts and building permits (F). Housing remains crucial if the economic rebound is to gain real strength. Building permits are a good leading indicator.
  • Michigan Sentiment (F). Good concurrent read on employment and spending.
  • Retail Sales (T). Continued rebound from the bad weather months?

The "B List" includes:

  • Industrial production (Th). Also capacity utilization, now approaching 80%, a level that suggests more Capex spending.
  • PPI (W). Inflation will someday be important, but not until it has exceeded the Fed's target level.
  • CPI (Th). See PPI above.

There are a number of regional Fed surveys. I do not regard these as very important (at least not individually) and it takes a big move in one for any real market impact. It is an active week for FedSpeak, including more from Chair Yellen.

Earnings season winds down. Ukraine remains a wild card.

It is options expiration week, so surprising moves sometimes become exaggerated. Option strike prices thought to be irrelevant suddenly come into play.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued the bullish rating, and the choices have become more aggressive. The broad market ETFs look better, except for IWM (The Russell 2000), which is neutral. More sectors have emerged from the penalty box, reflecting higher confidence in the ratings.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

Despite a little daily volatility, there have not been many good dips to buy for long-term value investors.

Those trying out our Enhanced Yield approach should have enjoyed yet another good week in a sideways market. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it.

Here are some key themes and the best investment posts we saw last week. For some reason, these are all things that you should try not to do!

Individual investors are bad market timers. Jason Zweig is a champion for this group with his regular column, The Intelligent Investor. He aggressively asks, Just How Dumb Are Investors? Stock fund investors made 3.7% annually over the last 30 years while the S&P 500 had annual gains of 11.1%. Basic reason? Investors chase returns, buying and selling the wrong mutual funds and getting out of the market at the wrong times.

The economy is stronger than you think, according to these nine reasons from Jeff Reeves's Strength in Numbers. He describes an unexciting story of modest growth, suggesting that it might be time to "push aside" the doom and gloom crowd. What fun would that be?

Beware of the advice from famous hedge fund managers. Barry Ritholtz warns about the need to distinguish between some famous "headline" calls and the overall results. Here is a key quote:

The 2013 results were similarly disappointing: a 3.8 percent loss for the conference's best picks versus the Standard & Poor's 500 Index gain of 15.2 percent. The pattern was the same in 2012: a 19 percent gain for the Sohn picks versus 22 percent for the S&P 500. (Note the gains are calculated conference to conference, and not on the calendar year).

Beware of the bubble callers. The legendary Jeremy Grantham has pedestrian returns, even with a defensive position during the last recession. Why? He was too early and got back in the market too late. Here is the full story, typical of many bubblers. For contrast, read also James A. Kostohryz, who asks what might happen if Americans were actually optimistic.

Beware the hype machine. Tom Brakke describes what happens when sell-side analysts write about companies where there are also stock offerings. See his great case story and chart.

Beware of "inside" information. Most people are suspicious of those who are selling information instead of using it themselves. Here are several reasons for walking the other way!

 

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

Divergences seems like a manufactured problem. Take a look at this chart from Bespoke.

They analyze the strength of the NASDAQ Internet Group last year and the recent weakness, noting that "the tortoise could catch up to the hare."

It is normal. It is what you should expect when attitudes change about sector valuations. We always see changes based upon perceptions of where we are in the business cycle as well as sentiment. It is not just about company size. At some point, I expect the current dividend favorites to lose ground to cyclical and financial names. That is business as usual.

Here is a simple test:

When these more speculative stocks were surging last year, did analysts now warning about "divergences" celebrate the "confirmation" of the strength of the market? Or did they warn that the market was in a "bubble?"

If the latter, isn't it healthy to restore more normal valuations?

Author: "oldprof"
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Date: Monday, 05 May 2014 05:00

How worried should we be about the Ukraine crisis?

Last week some regular readers whom I respect asked why I did not mention the Ukraine situation. It was a fair question, given the attention from the financial media. My answer was that it was an important story on many fronts – defining the future Putin role, setting precedents for NATO and the us, and of course, the people directly suffering in the conflict. I did not view it as a "market crisis" despite the 50 basis point moves that are often attributed to Ukraine news.

Since it is a light week for data, the field is open for more pundit pontification, perhaps including a few who can actually find Crimea on a map and know a few facts.

Prior Theme Recap

Last week I expected a repeating chorus of "sell in May" no matter what happened on the economic front. That was a good guess. We were bombarded with articles on that theme and most cited that type of data that I warned about last week. The actual data were quietly positive, and so was the market.

Forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

Is the Ukraine situation a market crisis?

Saying "Yes" are those who take one of the following positions;

  1. There is a chance of armed conflict between Russia and the US or NATO;
  2. Sanctions against Russia will cripple the entire European economy, upsetting the oil trade relationship;
  3. Increased energy prices will derail the European economy with a possible ripple effect.

Saying "No" are those who focus on quantitative impacts.

  1. There is no indication of direct conflict, only an escalation of sanctions;
  2. Global trade is supposed to bring the world closer together. This is a test:
  3. Increased energy prices may not enrich the leading Russians.

This might be a compelling story in a week that is light on data. There will be some early spin on the Buffett weekend, and also some earnings news. Will the market decide to take the Ukraine issue seriously?

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.


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

There was plenty of economic news, and on balance it was pretty good.

  • Earnings – both reported and expected – are solid. Brian Gilmartin has an excellent analysis of the current earnings season and the implications. Higher expectations are in place. What multiple will the market accord?
  • Case-Shiller home prices were up almost 13% year-over-year. This was the expected increase, but "good news" because of question marks on other recent home sales data.
  • Auto sales were encouraging, especially the Ford F-150 truck, which tracks small business and construction. This is a good one for those conspiracy buffs who are suspicious of the "official" numbers. (Via Bespoke).

The Bad

There was also some bad news.

  • GDP growth in Q1 was anemic. It is certainly bad news as the base for future growth. The market seems to be granting a "weather exception." We shall see. Some sources see the quarter in negative territory. (Merrill Lynch via Calculated Risk).
  • Initial jobless claims rose again, to 344K. Job losses are only half of the story when it comes to net job creation, but this data series has been a good indicator.
  • Employment growth is concentrated in the low-wage jobs. The NY Times has good coverage.

The Ugly

Dissatisfaction with where you live. I confess that I was astounded by the recent Gallup survey asking people if they would prefer to live in a different state. Before looking at the result, what do you suppose would be the high and the low? Do you think that many people want to move, or are generally satisfied?

It turns out that even in Hawaii (and Montana) 23% of the residents would rather live elsewhere. That is the best. I am surprised.

On the negative side, half of the residents of my state (Illinois) would rather move on. This would be a good question for "Family Feud." How many of the best and worst states could you name? I think the big story is that so many would like to move. This probably has implications for employment, inability to sell homes, and other issues. Here are the tables of the worst states and the best:

Runner-up this week: Prop traders' failure rate. The TV ads make it seem so easy……

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in Canadian stocks, Georg has unveiled a new system.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile punditry.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. He notes that the ECRI has emerged from hibernation. "Interestingly, the interview includes no reference to ECRI's recession call, instead focusing on whether the winter economic downturn was weather-related or reflective of a cyclical downturn."

If you had to pick a single indicator for concurrent economic strength, a summary of what the NBER looks at when determining the start and end of recessions, you would follow Doug Short's regular Big Four summary.

The Week Ahead

We have a light week for news and data.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on employment.
  • ISM services (M). Not as widely followed as the manufacturing index, but still significant.

The "B List" includes:

  • Trade balance (T). Key GDP component.
  • JOLTS report (F). Job openings rate is interesting but the quit rate is most important.

With the FOMC meeting over, we can expect the resumption of FedSpeak. I do not expect anything significant.

We have continuing earnings news, as well as more from Ukraine.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued the bullish rating, but it is still a close call. We have been mostly out of US equities, but fully invested for trading accounts. Somewhat to my surprise, we never got a "buy" signal on the inverse ETFs. The Dow and the S&P 500 look better and the QQQ's have also rebounded to the neutral range. Many more sectors have earned good ratings, but are still in the penalty box, reflecting higher uncertainty.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

Because we have been trimming winners in our "long stock" program, we have prepared to buy on dips. I have added some to these positions yet, and we are shopping. I am especially interested in regional banks, energy and some "old tech."

Those following our Enhanced Yield approach should have enjoyed yet another good week in a sideways market. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it.

Here are some key themes and the best investment posts we saw last week.

Be a good consumer of investment information. Regular readers know that I applaud the advice from Barry Ritholtz, suggesting that you take the role of skeptical litigator. Ask about the motives and biases of the source. Barry writes:

 

If you consume lots of stock research or market commentary — or much of anything from the financial media — then you will find this exercise especially important. Let's look at the motivations of various pundits, strategists and fund managers. Suit up in your finest barrister gear; we are going to play "cross-examining litigator" for fun and profit.

You should read the entire list of characters, but I will take the liberty of quoting two entries – enough to whet your appetite. The combination is powerful, and an explanation of how so many have been so wrong for so long.

 

The end-of-the-worlders: Since the rally began in 2009, we have seen the usual crowd of Web sites, newsletter writers and pundits forecasting a terrible crisis that you simply must note: The Fed has run amok. We are running out of food. Fiat currency is soon to be worthless.

They seek to take advantage of your tendency to succumb to the recency effect, where you place excess value on what just happened. After the financial crisis, your natural tendency is to look for another one, and they have just the newsletter to help you with that. Let me remind you that the end of the world bet has yet to pay off, and when it finally does, whom are you going to collect from?

Gold bugs have a narrative, which they pursue regardless of new data. My favorite oft-forgotten factoid is that the SPDR Gold Shares ETF (GLD) was the brainchild of the World Gold Council. WGC was created by global mining companies for the sole purpose of promoting the sale of gold. The GLD ETF came about after "two decades of depressed prices and a growing glut of the yellow metal." As we discussed here, GLD was a bit of a Hail Mary to find a way to deal with price and inventory pressures. (Mission accomplished).

Imagine a Venn diagram showing a cross-section of gold bugs and doomers, and you end up with the "physical gold" crowd. They insist: "The whole system is going to collapse, you cannot even own the ETF — you must own physical gold!" And they are happy to sell some to you.

Don't mix politics with your investing! (Where have we heard that before?) A big fund manager has this warning for his wealthy investors:

 

The founder of Greenspring — which manages nearly $1.8 billion from Towson, Md. — says basing investment decisions on emotional views about Obamacare, unemployment or the deficit instead of more relevant information can seriously threaten a client's financial plan. "The worst short-term risk is missed opportunity," says Collins. And in the long term, "going to cash will make it so that you can't sustain your lifestyle as you should."

Bullish Charts. The charts showing a gloomy ten-year forecast get a lot of press. Here is an alternative view from Ryan Detrick – you need to read the entire post to understand the analysis. He concludes, "…bigger picture this says there is still a lot of room to move higher over the coming years."

 

 

 

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

Let us suppose that you are a trader. You are trained to look for the market implications from any news. Suppose that there is some escalation of tension in the Ukraine. It cannot possibly be good news, so the general reaction is to sell. Depending upon where the market is in the daily trading range, a little selling can beget more selling. It really does not mean much.

If you are a long-term investor, shopping for new positions, you can use volatility to your advantage.

If you are a trader, these news events are not very helpful. The news from the Ukraine is unpredictable in nature, size, and market effect. Traders are reacting without much evidence.

That is why the market moves – despite the media hype – are rather small. The quest to explain every 50 basis point move in the markets is Quixotic.

Author: "oldprof"
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Date: Sunday, 27 Apr 2014 20:32

Can positive economic trends overcome the weight of market seasonality?

We all love simple rules, especially when supported by data. Throw in a rhyme or some alliteration and you have the makings of a powerful slogan. "Sell in May and go away" fits the bill.

Despite the biggest flow of fresh news and data we have seen in recent memory, I expect the financial punditry to repeat the rhyme and ask that question to anyone willing to step in front of a microphone.

Prior Theme Recap

Last week I expected the theme to be economic optimism. There were several stories on that subject early in the week. It played out pretty well until the release of the new home sales data. That caused most to reconsider. Despite that, the balance of news and corporate reports were upbeat on the economy.

As I try to emphasize, forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

Is it time to "Sell in May?"

There are many articles on this subject, but charts like this one (from Sam Ro at Business Insider) highlight the seasonal difference:

We'll let that chart stand for a thousand words!

If you insist on more detail, you can find scores of articles that suggest that this is the exact moment for many bearish predictions to come true – "only pain ahead."

On the positive side, there are five important trends suggesting solid economic improvement:

  1. Less economic uncertainty. Remember all of the complaints that business was reluctant to expand because of unpredictable government policies? That has gotten better. Fivethirtyeight has a nice update article in an objective indicator, the economic policy uncertainty index.

Economic uncertainty

  1. Corporations are finally putting cash to work (via Bloomberg) although it is only a start (via Scott Grannis).
  2. Expected earnings growth remains strong. Brian Gilmartin provides regular updates of the growth in the forward estimate, now 7.68%.
  3. US oil production is surging, up 67% in four years. Scott Grannis calls this a "huge boost for the US economy."
  4. Business economists see improved hiring. These are not Wall Street economists or academics (although their message is similarly upbeat). These are corporate economists offering evidence about their own business or sector. This is the best kind of survey. Josh Brown has a nice discussion, noting that we have had four annual "false starts" toward the elusive goal of economic "escape velocity."

How much of an anchor will seasonal forces provide? Will economic progress be reflected in stock prices?

As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.


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

There was plenty of economic news, and on balance it was very good (including key trends highlighted above).

  • Durable goods growth was strong at 2.6%, well above forecasts of 2.0%. Growth in core goods was also well above expectations. See Steven Hansen at GEI for comprehensive analysis and charts.
  • Michigan sentiment climbed to 84.6. This was the second highest reading in almost seven years. Values are still well below the pre-recession days, but the results are encouraging. See Doug Short for complete analysis and my favorite chart of this series.
  • Leading economic indicators were up 0.8% -- strong and above consensus.
  • Property tax collections are back at the pre-recession peak. (See Calculated Risk).

     

The Bad

There was also some bad news, most importantly the housing data.

  • The revenue beat rate is weak – only 50%, which is well below the 59% average. The earnings beat rate has been acceptable at 62%, the average of the last few years. Bespoke has the full story including this chart:

  • China's growth remains disappointing. The Manufacturing PMI edged higher, but has been in the contraction range for three months. Dr. Ed Yardeni explains that the weakness reflects less government stimulus and is affecting demand for commodities, including oil. Here is a key chart:

Yardeni china growth

  • Initial jobless claims spiked to 329K. This is a noisy series, so the focus is on the four-week moving average, but it bears watching.
  • New home sales plunged by 14.5% on a seasonally adjusted basis. The March data should have had reduced effects from weather. John Lounsbury and Steven Hansen analyze this noisy series with a focus on unadjusted data and comparative moving averages. New Deal Democrat wants some dap for his bearish call on housing, so check out his reply to Calculated Risk and Joe Weisenthal. Here is a chart from the GEI analysis:

  New home sales

 

 

The Ugly

Health care costs for the elderly. A new study suggests that middle-class retirees may need to use their entire Social Security benefits to offset health care costs. The costs are the Medicare and Medigap premiums as well as co-pays. The costs are projected at 98% of Social Security benefits for a healthy copy retiring in ten years.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

  Indicator Snapshot 042614

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in Canadian stocks, Georg has unveiled a new system.

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile punditry.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. He notes that the ECRI is back in "hibernation."

The Week Ahead

We have a very big week for news and data.

The "A List" includes the following:

  • Employment situation report (F). A complex and heavily revised story, but viewed as the most important read on the economy.
  • FOMC decision (W). Strong consensus on the outcome, but wording will get attention.
  • ISM Index (Th). Key gauge of trend in manufacturing and employment.
  • Personal income and spending (Th). Important element of GDP.
  • Consumer confidence (T). Good read on employment and spending.
  • Initial jobless claims (Th). Best concurrent read on employment. Will the improvement be maintained?

The "B List" includes:

  • ADP employment (W). Good independent measure of private job growth.
  • Auto sales (Th). Will growth rebound?
  • Pending home sales (M). Plenty of attention on housing.
  • GDP (T). Backward looking and low expectations, but still the ultimate growth measure.

Fed Chair Yellen speaks on Thursday, after the FOMC meeting. No press conference for this one.

Major earnings reports continue and may overshadow economic news.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has shifted to a bullish rating, but it is still a close call. We have been mostly out of US equities, but fully invested for trading accounts, mostly in Latin America. Somewhat to my surprise, we never got a "buy" signal on the inverse ETFs. The Dow and the S&P 500 look better and the QQQ's have also rebounded to the neutral range. Many more sectors have earned good ratings, but are still in the penalty box, reflecting higher uncertainty.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

Because we have been trimming winners in our "long stock" program, we have prepared to buy on dips. I have not added to these positions yet, but we are shopping. I am especially interested in regional banks, energy and some "old tech."

Those following our Enhanced Yield approach should have enjoyed another good week in a sideways market. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it.

Here are some key themes and the best investment posts we saw last week.

Most investors are still sidelined. A Bankrate.com poll shows that 73% of people are still "nor more inclined to invest in stocks." Chief financial analyst Greg McBride notes, "A lot of individual investors got burned twice and as a result they swore off investing in equities."

Investors favor real estate and gold rather than stocks according to Gallup. Gold is especially popular with low income Americans.

  Gallup on Gold

Meanwhile, affluent US investors are very bullish on equities (according to a Legg Mason survey). 74% thought that equities were the best choice for 2014.

We all have a choice about investments, but it is interesting to see how others are behaving and which groups are more similar to your own thinking.

Ideas? For those interested in finding some solid stocks, there are plenty of attractive values. David Bianco highlights Apple (AAPL), JP Morgan (JPM) and Chevron (CVX) as examples of companies that will do fine if the economy muddles through the rest of the year and even better if it accelerates. He states, "Either way you win with these stocks." (I am long all three names in our stock and/or enhanced yield programs, since this value approach is much like ours).

If you are obsessed about possible market declines, you can see that you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

The seasonal slogans often substitute for thinking and analysis. The powerful-looking chart that leads today's post actually translates into a 1% monthly difference in performance. The "good months" gain 1.3% on average while the "bad months" gain about 0.3%.

To make a wise decision you need to make an objective quantitative comparison between the economic trends and the small seasonal impact. The Great Recession has been followed by a slow and plodding recovery. We have an extended business cycle with plenty of central bank support. Since I am expecting the current cycle to feature (eventually) a period of robust growth, I do not want to miss it. The 1% seasonal effect will be minor in a month where we get a real economic surge.

If instead we get the typical sideways market with some volatility, it is a perfect environment for selling short-term calls against attractive, dividend-paying stocks.

Take what the market is giving you – often a path not chosen by the crowd.

Author: "oldprof"
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Date: Sunday, 20 Apr 2014 04:28

Some weeks feature a contrast between past and future -- a possible inflection point. Here are the current elements:

  1. Important economic data with a forward look;
  2. Earnings news from major companies reporting on Q114;
  3. Corporate conference calls explaining the outlook for future earnings; and finally
  4. Economic implications for improved economic growth and business conditions worldwide.

It is a big week for news and data.

Prior Theme Recap

Last week I expected the theme to emphasize volatility. The market was at interesting technical levels and there was plenty of news to push it one way or the other. In a sense I was right about the theme, since the talking heads made the moderate crossings of "unchanged" seem like big news. The volatility cocktail was more like a Shirley Temple.

The potential was there, but the economic news was mostly calming. The contribution of mixed corporate earnings was enough to prevent a major market move either way. It is easy to measure volatility objectively. The VIX index gauges the market expectations for changes in the S&P 500. (If you spend five minutes with this post from Bill Luby at VIX and More, you'll know more than almost anyone about the VIX). Here is the chart for the week:

By the end of Thursday's trading, the options market was already factoring in a quiet three-day weekend.

While the theme did not play out last week, it looked promising on Monday and Tuesday. Here is what I wrote last week:

If earnings satisfy, it might have a calming effect. This will be especially true if we get a little more confidence in forward outlook, some hints about future hiring, and more planned capital expenditures. In that case we could have a rebound, with plenty of reduction in the VIX.

As I try to emphasize, forecasting the theme is an exercise in planning and being prepared. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

At economic inflection points it is normal to have a mix of optimists and pessimists.

  • Representing the pessimists we have a trader perspective that was well-received at Seeking Alpha. The argument is one I frequently hear from trader friends and individual investors. The author examines various trends before concluding as follows:

    Hence, I expect the Fed to continue with its one-size-fits-all approach of QE, opting to reverse tapering and return its foot on the monetary accelerator. But, having largely continued stalling for the past five years, I also expect the gears of the economy to remain stuck in neutral. A stagnant economy that is held up artificially and not allowed to correct naturally but that also lacks the inherent energy and dynamism to grow with any persistence and sustainability.

  • On the side of the cautious optimists (the only brand we see), Chuck Mikolajcak at Reuters has the story: Wall Street Week Ahead: Spring fever brings hope for U.S. earnings. He notes that the upcoming reports reflect a cross-section of companies, an end to cold weather worries, and special attention to Chinese growth slowing.

  • A more balanced look comes via Josh Brown. He notes that we might see the first actual decline in quarterly earnings since 2012, and explains the lower and beat pattern of the expectations game. Josh writes as follows (and also provides a helpful chart):

    …(T)he good news is that analysts have been willing participants in the beat-and-lower phenomenon for years now. You can see the downward revisions (green bars) being handily exceeded by actual results almost every time. Beat rates for the S&P as a whole have been running at a rate of 60 to 70% pretty consistently for the period pictured. We'll see if they can pull it off again and avoid the first quarter of year-over-year negative earnings growth since Q3 2012.

From these sources, it would seem that we should not expect much economic and market optimism, even as the weather improves. As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.


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

There was plenty of economic news, and on balance it was very good.

  • Rail traffic is showing strength. GEI has good advice on how to look past the noisy weekly data. The post also has plenty of charts for those who want to do their own research.
  • Hotels are having a big year, the best since 2000 according to Calculated Risk. That squares with my own travel experience.
  • Fed news was positive. The Beige Book showed a positive outlook (via the WSJ) and Fed Chair Yellen made an encouraging speech, without any slips about the timing of rate increases.
  • Retail sales rose 1.1% beating expectations.
  • Greece bond yields decline further, now below 5%. Felix Salmon has a nice post citing the top five reasons for the successful auction. Your favorite perma-bear or conspiracy site either did not mention this news, or asserted that disaster still looms. It is interesting that some use "kicking the can" to apply to policies, but not to their own errant predictions. If you missed my "Faceoff" piece – Jeff versus John Mauldin on the record you can see what we both thought a few years ago. That is always more challenging than coming up with reasons after you know what happened.
  • LA port traffic has hit another new high. Bill McBride at Calculated Risk has the full story and charts, concluding, "This suggests an increase in trade with Asia in March." 
  • Sentiment is more negative and that is a positive since it is a contrarian indicator. Barry Ritholtz explains and provides this chart:


  • Industrial production beat expectations. Scott Grannis sees this as part of an overall picture of economic strength. (Full discussion with charts).

     

The Bad

There was also some bad news, but not much. I am sure that some of my commenting community will want to add some bad news, but remember that it is supposed to be something that happened last week.

  • Gasoline prices continue to rise. The move has surprised many. Doug Short has a great chart and plenty of additional background in his post.

  • China disappointed in several economic fronts. The headline GDP report of 7.4% growth missed the official 7.5% target. While markets seemed to expect this, this does not suggest more stimulus. Ed Yardeni reports on weak exports, deflationary signals, and the failure to sell about a quarter of a one-year bond offering. The finance minister would not offer an adequate yield. Here is a great chart on the disappointing China progress:

  • Housing starts show modest growth. Building permits also remain weak. Calculated Risk continues to see a "wide bottom" in these indicators with a positive outlook. See the full post for more color.
  • Eurozone growth is lagging. Ed Yardeni suggests that we need a magnifying glass to see progress from last summer. Here is a key chart:

 

The Ugly

Germs. There is a lesson here about perception and reality. There is a modest risk from a disgusting source, and a big risk from a routine one. Which do you suppose gets a public reaction?

Dirty money (via the WSJ) explains that "a body temperature wallet is a petri dish" for microbes. It is something to think about the next time you see a food worker handling money. But then you often do that yourself right before eating.

Portland empties a reservoir after security cameras showed a thoughtless and selfish act. This had a negligible effect, but it was widely reported.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in Canadian stocks, Georg has unveiled a new system.

RecessionAlert: Great work on the "Yellen Dashboard". Dwaine's fans should also check out his S&P warning system, based on market breadth.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile punditry.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully. Doug also has an update of his "Big Four" chart, examining the most recent data. This is the single best look at concurrent indicators of a potential business cycle peak:

 

The Week Ahead

We have plenty of news and data in a short trading week.

The "A List" includes the following:

  • New home sales (T). Important read on both housing sector and economic growth.
  • Initial jobless claims (Th). Best concurrent read on employment. Will the improvement be maintained?
  • Michigan Sentiment (F). Best way to get concurrent information on spending and employment.
  • Leading indicators (M). Somewhat controversial, but still widely followed. A big jump is expected.

The "B List" includes:

  • Existing home sales (T).
  • Durable goods orders (Th). March data important to GDP.
  • FHFA housing prices (T). Very accurate, but only for a subset of housing.

Former Fed Chairman Bernanke speaks in Toronto on Tuesday. ECB President Draghi speaks on Thursday.

The big news is the avalanche of earnings reports.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has once again continued with a neutral rating. We have been completely out of US equities, but fully invested for trading accounts – all in Latin American or China. This was not as good as the US ETFs last week. Given the current ratings, it is possible that Felix will give a buy signal on an inverse ETF this week.

Those who want to follow Felix more closely can check us out at Scutify, where he makes a daily appearance to join in vigorous discussions about trading. This assumes that I can awaken him from his Spring fever and the attractions of those "high-frequency" models so popular here in Chicago.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

This is still an important time for long-term investors. We all know that market corrections of 15% or so occur regularly without any special provocation. Recent years have been the exception. Over the last several weeks I have emphasized the need to maintain perspective, using market declines to add to positions.

It helps if you have been actively rebalancing your portfolio and trimming winners. Then you have some cash. Some readers have asked me to write more on this topic, so I have placed it on the agenda. For now, let me do a quick summary.

  1. Review your holdings regularly. (For me, that means at least weekly, but it is my day job. Quarterly is probably enough for most people, perhaps with some price alerts). Make sure that your original reasons for the investment are still valid. Revise your fair value and price target estimates.
  2. Do not fall in love with a position. If hanging on to a disappointing holding, make sure your reasons are sound.
  3. Sell if your price target is hit.
  4. Rebalance by trimming if a stock appreciates massively, but remains below the price target.

Because we have been selling in our "long stock" program, we have prepared to buy on dips. We are following the rules that I have recommended for you. I have not added to these positions yet, but we are shopping. I am especially interested in regional banks, energy and some "old tech."

Those following our Enhanced Yield approach should have had a great month and quarter. We have experienced only modest volatility, continuing to beat our upside target for the year despite overall market losses. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls. I have written several times about examples that you can try on your own. It reduces your risk. Start small and get the sense of how to do it.

Here are some key themes and the best investment posts we saw last week.

Beware the Bubble Talk. It just does not stop. When one sign or signal fails, the enterprising bubble community finds a new one. Now it is the number of IPO's. Barry Ritholtz has a nice column at Bloomberg, analyzing five different indicators raised by Mark Hulbert. It is worth it to read the entire piece, and all the specific points, reaching the conclusion:

Taken as a whole, these five points suggests that speculation hasn't run rampant today the way it did in 2000. The list above contains two strong points, one moderate and two that perhaps could be rationalized away.

The conclusion is that we are not in a speculative bubble.

I will add that if there were few IPO's, that would be cited by many as a sign of market weakness. This is what comes from starting with a conclusion – more of a mission – and then seeking an argument.

Some sector selling might be excessive. It is early for any firm conclusions, but this is how you build your watch list. Bill Luby has an interesting analysis of the 2014 correction (!?). This gets plenty of media play. In fact, it is pronounced in some sectors and hardly noticeable in others. This is a good summary chart:

Energy is worth a look, according to earnings expert Brian Gilmartin. As he notes, I agree.

Dividend stocks can be dangerous. Some have yields that cannot be sustained or have reached excessive valuation levels. Michael Fowlkes offers some specific suggestions.

A simple timing method from Eddy Elfenbein will surprise you. It is much more powerful than the normal seasonal ideas you hear so much about. Just stay invested as long as inflation is between 0% and 5%. He writes as follows:

A few years ago, I ran the numbers on how the stock market reacts to inflation. Here's what I found:

Now let's look at some numbers. I took all of the monthly returns from 1925 to 2012 and broke them into three groups. There were 75 months of severe deflation (greater than -5% annualized deflation), 335 months of severe inflation (greater than 5% annualized), and 634 months of stable prices (between -5% and +5%).

The 75 months of deflation produced a combined real return of -46.77%, or -9.60% annualized. The 335 months of high inflation produced a total return of -70.84%, or -4.32% annualized. The 634 months of stable prices produced a stunning return of more than 177,000%. Annualized, that works out to 15.21%, which is more than double the long-term average.

Here's an interesting stat: The entire stock market's real return has come during months when annualized inflation has been between 0% and 5.1%. The rest of the time, the stock market has been a net loser.

Investors might enjoy seeing Eddy's speech to The Motley Fool.

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

There is a great divide in the economic blogosphere.

On one side you have non-economists who write pop economics. They are good with numbers and charts, and they speak a language that is plausible for a mass audience. The average person in the US claims economic expertise from being a consumer! Articles from these sources are replete with charts and references to headwinds. These are often "strategists" or people who became Wall Street economists without every studying the subject. Some are famous for being famous.

On the other side you have those with formal training and years of experience building and testing models. Their success is usually (with some exceptions) measured by accuracy of their forecasts and insight. They often have much less visibility, and frequently no specific mission, unless they work for a firm that emphasizes a single product.

One of the easiest ways the average investor can sort through the noise is by demanding some qualifications. Just check the bios of the sources. There are people who rise to the top of economic and statistical analysis without going through the program – Bill McBride and Nate Silver come rapidly to mind – but they are exceptions. They use professional techniques. Join me in becoming a demanding consumer of economic conclusions. (Hint: Quit reading when the post refers to Econ 101!)

Collective surveys like that reported monthly by the Wall Street Journal can be very helpful. Right now the consensus conclusion is an improving economy growing to the 3% trend level. Why? The long-term history shows that a free market economy works to employ slack resources, and we have plenty of that! This is not a business cycle peak, and therefore we do not face an imminent recession.

The investment conclusion should be that we are still in the middle innings of a prolonged recovery cycle, with plenty of time to enjoy the results.

What does that mean for investors? Stay focused on risk and fundamentals – not stock prices. The post-2000 market results have frightened an entire generation of investors. Whenever there is a bad stretch in the market, however brief, they are afraid of another "big one."

You can imitate what I do for clients.

  • Use our recession and financial stress indicators to warn of major risk. None of the major market declines occurred without a warning from these signals. When we get an elevated level, we reduce positions.
  • Right-size your positions. Expect that there will be 15-20% market drawdowns without a fundamental explanation. If this move will be too upsetting, your position is too big and you will bail out at the wrong moment. This is how I approach it with investors, and it is better than the silly questionnaires that some big firms use for CYA compliance.
  • If your position is the right size, then you are ready to be greedy when others are fearful – and vice-versa.
  • And most importantly, be willing to change with your indicators. If we see heightened risk, we will cut back on position size, just as we did in 2011.

And keep in mind, what we saw two weeks ago was a minor pullback from fresh highs. It was not even close to a full-blown correction, despite the media coverage. If you became uncomfortable and blew out of your position, it shows that you had not accurately evaluated risk.

Investing is not like a poker game, where you go "all in" or completely sit out.

Author: "oldprof"
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Date: Sunday, 13 Apr 2014 19:50

This week brings the makings of an explosive volatility cocktail:

  1. Important economic data;
  2. Key Q1 earnings reports;
  3. Options expiration;
  4. A short trading week; and
  5. An edgy market environment.

This is a very unusual combination, and the various elements will compete for attention.

Prior Theme Recap

Last week I expected the theme to test the divergence between economic fundamentals and what I called "fluff." The latter term referring to the collection of top-calling, market-rigging, crash charts, and "This is the big one" stories. This was one of my better forecasts. The economic news was excellent. The market was terrible. Everyone had an explanation – all different, all dubious.

This is another good illustration of the reason for my weekly post – planning for the week ahead. Readers are invited to play along with the "theme forecast." I spend a lot of time on it each week. It helps to prepare your game plan for the week ahead, and it is not as easy as you might think.

Naturally we would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.

This Week's Theme

I have almost 27 years of experience as a market professional. I cannot remember planning for a week like this one. Much depends upon the corporate earnings reports.

If earnings disappoint, it will be seized upon as confirmation of the bad economy, expensive stocks meme. Volatility will increase. Moves during options expiration can be exaggerated, since strike prices formerly thought to be irrelevant come into play. Markets could move much lower.

If earnings satisfy, it might have a calming effect. This will be especially true if we get a little more confidence in forward outlook, some hints about future hiring, and more planned capital expenditures. In that case we could have a rebound, with plenty of reduction in the VIX.

I have some thoughts that I will share in the conclusion. First, let us do our regular update of the last week's news and data. Readers, especially those new to this series, will benefit from reading the background information.


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

There was not a lot of economic data, but it was almost all good.

  • Aluminum demand is strong and growing. Whatever you think about Alcoa as a company or an investment (CrackerJack likes it), it is well-placed to comment on certain markets. Sam Ro has a good post on this topic, featuring the following chart:

  • Greece re-entered the bond market. There was a successful sale of 10-year bonds with a six handle instead of the 30% from a few years ago. Your favorite perma-bear or conspiracy site either did not mention this news, or asserted that disaster still looms. It is interesting that some use "kicking the can" to apply to policies, but not to their own errant predictions. I reviewed this in one of my occasional "Faceoff" pieces – Jeff versus John Mauldin on the record.
  • The Fed clarified the timing on short-term rate cuts. This seemed to walk back Chair Yellen's explanation during her maiden first press conference. (I would have written "maiden" for a man….. hmmm). The problem is that the Fed reports the forward guidance from the committee as a whole, but also the forecasts of individual members and staff. She warned not to focus too much on the individual forecasts, which have a specialized set of guidelines. There have been plenty of complaints about an excess of transparency leading to a confused message, and this seems to be an example. John Hilsenrath has a good explanation of the difference. The market celebrated the clarification from the Fed minutes.

  • Fewer people are going without health insurance. As always, I do not want to get involved in the politics of this subject. The overall solution is elusive. Meanwhile, there seems to be some progress. John Lounsbury at GEI picks up some key results from Gallup.

  • Jobless claims hit a new low, the best in nearly seven years. Bespoke has the full story and captures the importance for stocks in one of their great charts:

  • Job openings have increased to 4.2 million. Calculated Risk has good coverage. Personally, I would have liked to see a higher "quit rate."
  • The Ukraine reaction has been muted. I am certainly not saying that the issue is unimportant. It is crucial for the people involved and as a matter of foreign policy. Those are subjects for us as citizens. As investors, we merely note that the market has moved on. Scott Grannis has one of his full chart packs showing the best indicators for evaluating this topic.
  • Sentiment became more negative. AAII bullishness dropped to 28.5%. This is a contrarian indicator which has been recently highlighted by bearish pundits when it reached bullish extremes.
  • Michigan sentiment beat expectations. The current value is still in a range somewhere between healthy and bad. I have a special fondness for this report, and it extends beyond institutional loyalty to my old school. I like the methodology, with a continuing panel as part of the survey. My own research has shown a link between these findings and important variables like employment and spending. Doug Short, as he does so often, brings the data to life by showing the current level, past values, the GDP, and recessions – all in a single chart.

 

The Bad

There was also some bad news, but not much. I am sure that some of my commenting community will want to add some bad news, but remember that it is supposed to be something that happened last week.

  • China reported weak trade data, down 6.6% from a year ago (via CNBC). I am scoring this as negative, and it was a big disappointment. Asian stocks were lower and it pressured the US. Everyone understands the significance of China for the world economy and especially emerging markets. I track this news, good or bad, with reluctance because I do not really trust the reports. In this particular case, the bad news may be exaggerated because last year was inflated. Bloomberg and Business Insider both have good stories. We need more and better data on China. I do not have a good answer for this.

    "We believe the real situation is not that bad, and could be quite normal, by analyzing two distortions, namely the Lunar New Year (LNY) and fabricated trades last year," Bank of America's Ting Lu wrote in a note to clients.

    The impact of the Lunar New Year holiday was expected and Ting thinks frontloading exports, gave the January data a boost.

    It's the impact of the inflated trade data from last year which is getting a lot of attention.

 

  • Technical indicators are more negative. Assorted moving averages have been breached and bullish setups violated. Even Felix (see below) has become more cautious, on the verge of an outright bearish three-week forecast.
  • Market reaction. I generally stick to the underlying data, but sometimes the market mood is the story. When good news gets ignored, it is noteworthy. One of the best ways to track the market week is Doug Short's excellent summary and chart:

The Ugly

The NSA. Reports are that they have long been aware of that Heartbeat Bug that we have been hearing so much about – the one that might be compromising our passwords and online transactions. Bloomberg reports that they chose to use the information for their own purposes. Let the denials begin….

Humor

We all deserve some laughs, so how about this one? Fargo sixth-graders beat college investors in a stock-picking contest! (AP with HT to The Kirk Report's excellent weekly magazine). The contest organizer made his first ever trip to ND. Here is his reaction and the comment of one of the entrants:

Walia said he was "blown away" with the level of thinking by the Oak Grove investors. Not all of the students were taking credit, however. Ben Swenson, who invested in Stratus Properties Inc., had another explanation for the high returns.

"I think it was sheer luck," he said.

I recommend taking a look at the winning portfolio (which probably did not do well last week). There is a good lesson in this, in addition to the fun.

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg's BCI index also shows no recession in sight. For those interested in Canadian stocks, Georg has unveiled a new system.

RecessionAlert: Great work on the "Yellen Dashboard" which we cited last week. Dwaine's fans should also check out his S&P warning system, based on market breadth.

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (2 ½ years after their recession call), you should be reading this carefully.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured "C Score." One of his conclusions is whether a month is "recession eligible." His analysis shows that none of the next nine months could qualify. I respect this because Bob (whose career has been with banks and private clients) has been far more accurate than the high-profile punditry.

Prof. Robert Shiller joins those who believe that recession odds are low. Rob Wile of Business Insider has the story, featuring this chart as the key reason:

The Week Ahead

We have plenty of news and data in a short trading week.

The "A List" includes the following:

  • Housing starts and building permits (W). An important read economic growth for the rest of 2014.
  • Initial jobless claims (Th). Best concurrent read on employment. Will the improvement be maintained?
  • Fed Beige Book (W). Anything from the Fed is still getting a big market reaction. This is the collection of anecdotal evidence that policymakers will have in front of them at the next meeting.
  • Retail sales (M). Rebound after the weather effects?

The "B List" includes:

  • Industrial production (W). Key GDP element.
  • CPI (T). Eventually inflation will matter, but not yet.
  • Business inventories (M) February data, but useful in interpreting GDP and ISM data.

It is a quiet week for Fed speechifying. I do not expect much from the regional Fed surveys.

The big news is the serious start to earnings season.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued with a neutral rating. We have been completely out of US equities and enjoyed a brief, but profitable, investment in bonds (via TLT). By the end of the week we were fully invested for trading accounts – all in Latin American or China. Those who want to follow Felix more closely can tune in at http://www.scutify.com/, where he makes a daily appearance – assuming that I can awaken him from his Spring fever and the attractions of those "high-frequency" models so popular here in Chicago.

Felix emphasizes momentum, but with many modifications. Cam Hui has a great post on how many methods work, but not all at the same time. So true.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current "actionable investment advice" is summarized here.

This is still an important time for long-term investors. We all know that market corrections of 15% or so occur regularly without any special provocation. Recent years have been the exception. Over the last several weeks I have emphasized the need to maintain perspective, using market declines to add to positions.

It helps if you have been actively rebalancing your portfolio and trimming winners. Then you have some cash. Some readers have asked me to write more on this topic, so I have placed it on the agenda. For now, let me do a quick summary.

  1. Review your holdings regularly. (For me, that means at least weekly, but it is my day job. Quarterly is probably enough for most people, perhaps with some price alerts). Make sure that your original reasons for the investment are still valid. Revise your fair value and price target estimates.
  2. Do not fall in love with a position. If hanging on to a disappointing holding, make sure your reasons are sound.
  3. Sell if your price target is hit.
  4. Rebalance by trimming if a stock appreciates massively, but remains below the price target.

When Mrs. OldProf wasn't looking, I violated our "no work on celebration nights" agreement to post an update on how we were trading the market volatility. If you have been reading the WTWA series, you were not surprised. (And thanks for all of the kind Birthday wishes in comments and emails).

Because we have been selling in our "long stock" program, we have prepared to buy on dips. We are following the rules that I have recommended for you. I have not added to these positions yet, but we are shopping. I am especially interested in regional banks, energy and some "old tech."

Those following our Enhanced Yield approach should also be doing fine. We have experienced only modest volatility, continuing to beat our upside target for the year despite overall market losses. It is important and helpful to own value stocks that pay dividends and add some hedging via short calls.

Here are some key themes and the best investment posts we saw last week.

Bonds continue to beat stocks. Brian Gilmartin has a thoughtful post that reflects how many of us feel. This demand for Treasuries is unrelenting. There is no easy explanation. Most of those claiming victory were asking "Who will buy our bonds?" only a few weeks ago when the QE tapering became clear. The economy is better. There are new pundit ideas, but they all seem like reaching.

The bond yields make sense only if the economy gets worse. The evidence is against this, so I expect the bond to stock rotation to resume.

To this advice, I add that most people lack the discipline to buy and sell at the right times. Every week I hear about people who bailed out of the market in 2009 and never got back in. You can be a do it yourselfer, but you need to ignore most of the pundits, popular web sites that promote fear, and focus on hard data. Howard Gold provides evidence about the results and the various errors:

The mistake concept is supported by academic research as well. Cass R. Sunstein writes about a personal investment mistake, over-estimating risk and the probability of loss. This is a smart person (like you) who has the same human tendencies. Check out the full article for the three causes of his error.

If you simply must do some hedging of your portfolio, beware the leveraged ETFs. Read this article carefully if your time horizon is more than a single day.

As usual, Barry Ritholtz has some great advice for the individual investor. He hits on the popular theme of the week: "I was right!" Of course that is claimed by many pundits with different explanations. Nothing has changed, but all of a sudden their pet theory has gained traction. He writes as follows:

Of course, all of these narratives serve a singular purpose: They give the appearance of meaning and rationality to actions that are meaningless and irrational. The daily action in the markets is a form of noisy, random, Brownian motion. If you are looking for a clear reason as to why stocks did what they did, then you are in the wrong line of business.

Given that truth, it was with great pleasure this morning I read a headline in the Wall Street Journal that accidentally reflected this reality: "Biotech Stocks' Rout Perplexes Analysts."

If you are obsessed about possible market declines, you have plenty of company. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

While it is easier to say than to do, investors should focus on risk and fundamentals – not stock prices. The post-2000 market results have frightened an entire generation of investors. Whenever there is a bad stretch in the market, however brief, they are afraid of another "big one."

You can imitate what I do for clients.

  • Use our recession and financial stress indicators to warn of major risk. None of the major market declines occurred without a warning from these signals. When we get an elevated level, we reduce positions.
  • Right-size your positions. Expect that there will be 15-20% market drawdowns without a fundamental explanation. If this move will be too upsetting, your position is too big and you will bail out at the wrong moment. This is how I approach it with investors, and it is better than the silly questionnaires that some big firms use for CYA compliance.
  • If your position is the right size, then you are ready to be greedy when others are fearful – and vice-versa.
  • And most importantly, be willing to change with your indicators. If we see heightened risk, we will cut back on position size, just as we did in 2011.

And keep in mind, what we saw last week is a minor pullback from fresh highs. It is not even close to a full-blown correction, despite the media coverage. If what you see makes you uncomfortable and interferes with your regular life, your position is too big.

The fundamental story is an improving economy and a reduction in risk that we can measure objectively. Calculated Risk has a nice summary of the economic prospects for the rest of the year. Bill is drawing upon the work of Goldman's Ian Hatzius, who is no perma-bull. Hatzius was Nate Silver's "hero" in the 2007-08 cycle. Here is the outlook:

US economic growth is accelerating as the economy bounces back from the inventory and weather-related weakness of the first quarter. Our current activity indicator (CAI) is up a preliminary 3.6% in March, well above the 2% pace of the prior three months and consistent with our forecast for a rebound into the 3%-3.5% range for real GDP growth in the remainder of 2014.

If this is accurate – or even close, we will see stronger corporate earnings, higher bond yields, and higher stock prices.

Author: "oldprof"
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Date: Friday, 11 Apr 2014 00:57

I planned to take tonight off since it is my Birthday and Mrs. OldProf is preparing my favorite dinner.

On the other hand, I like to post whenever there is a market development that will get a lot of media buzz and contribute to investors being Scared Witless (TM OldProf). Please check out last year's post on this theme and remember how it played out.

Here is the brief message:

This is exactly what I said would be the theme of the week: Fluff or Fundamentals. If you have a list of stocks that you like, with appropriate price targets, you are happy to go shopping when the market provides the opportunity. It is a classic example of fundamental value stock analysis. If you have been following us with the Enhanced Yield approach – buying reasonable dividend stocks and selling short-term calls --- your portfolio has hardly budged during the selling. You stand to collect next week as the call premiums wither.

If you do not have a good reason for your stock ownership, you will be tempted to bail out at the wrong moment.

As noted in past posts, I have been selling some holdings as price targets were reached. I have some cash, and I am looking for bargains.

Specific Changes

I want to update my commentary from the start of 2014. I still like the overall market prospects and the specific themes that I cited. Some of the names have changed. These have been profitable moves so far, but some adjustment may be warranted. Here is what I have done:

  • CAT – I have sold Caterpillar because the story has become too complicated and it hit my current value target. There are better cyclical plays.
  • NLY -- I have sold NLY because it is not meeting my objective as a play on increased slope in the yield curve. The market may not be perceiving the company strategy. For whatever reason, it is trading with interest rates, and that is not what I want. I buying regional banks that fit the mold better.
  • CTSH – sold because it reached the price target.

These have all been profitable ideas, but I am moving on to better themes. That is implicit in a preview for the entire year, but it has changed so quickly that I wanted to provide an update.

Time for dinner!

Author: "oldprof"
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