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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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Date: Wednesday, 09 Apr 2014 03:39

About two years ago the situation in Greece was at a flashpoint. It was at the top of the list of investor worries.

Leading that argument was John Mauldin, who had written over thirty posts tagged Greece culminating with aggressive statements in June, 2012. He also has a book on the impending collapse of Europe using Greece as the poster country for a debt-ridden collapse. Mr. Mauldin has noted in his interesting and lively weekly reports that he has met with Congressional leaders who were influenced by his reasoning.

At the same time, I suggested to readers that the Greek situation was overblown. Investors could achieve a significant edge by taking a contrary position. Here is what I wrote in June, 2012:

I have a long-term forecasting record on this which has been pretty accurate on general European developments.  It is dragging out longer than even I expected, but I still see the following conclusions:

  • Some sort of deposit insurance for Europe, ending the bank run worries that have dominated the stories for the last several weeks.  Do you really think that European leaders have no plan for this?  This will be the first news.
  • More powers for the ESM -- either direct lending to banks, or giving bank powers and leverage to the ESM.
  • Expanding the war chest -- this will happen gradually.
  • Concerted action by G8 powers -- quite possible, and already rumored.
  • Political and fiscal integration -- probably happening since most countries will benefit.  I do not know about Greece, but I will note that an exit now is much less painful than it would have been a year ago.  This illustrates why it is useful for leaders to buy time.

The Interim Update

US stocks are up about 40% since June of 2012. The European situation has not collapsed. It was (yet another) scary thing for the average investor, who was told to fear Greece, Europe, and world-wide debt.

Those who made these predictions are doing their own version of "kicking the can" by insisting on the same old themes and saying "Not yet…but eventually."

Meanwhile, Hugo Dixon, writing at Breakingviews, highlights Greece Unbound. Here is his account of the success of European policy --- at least so far.

Greece is undergoing an astonishing financial rebound. Two years ago, the country looked like it was set for a messy default and exit from the euro. Now it is on the verge of returning to the bond market with the issue of 2 billion euros of five-year paper.

There are still political risks, and the real economy is only now starting to turn. But the financial recovery is impressive. The 10-year bond yield, which hit 30 percent after the debt restructuring of two years ago, is now 6.2 percent. 

And…

Athens' debt is still almost 180 percent of GDP. But it is not nearly as burdensome as the headline figure suggests because the bulk of the debt is owed to other euro zone governments as a result of its two bailouts. Not only do these loans pay a low interest rate of a little over 2 percent, Athens doesn't need to start repaying them until 2022 and then has another 20 years to complete the job.

And in conclusion…

This is not to suggest Greece is out of the woods. A quarter of the workforce is still unemployed. To bring this down to acceptable levels, the government will have to continue with its reform agenda and the economy will need to grow for many years.

The biggest risk is politics. Only last week the government was shaken when a video was released of the prime minister's chief of staff talking to the spokesman of the far-right Golden Dawn party. The aide, who has since resigned, said two government ministers had told a judge to arrest the Golden Dawn's leadership. The ministers have denied this. It doesn't look like the government will fall. But if it does, a government led by Syriza, the radical left opposition, would be less investor friendly.

That said, the imminent bond issue is an important milestone in Greece's recovery.

 

Investor Conclusion

John Mauldin has over a million readers. He has monetized his eyeballs with subscriptions, conferences, taped replays, and paid promotions. His business model has been brilliant. He is a hard-working and charming person. I admire entrepreneurs and I congratulate him on is success. I have corresponded with him, and spoken on the phone, but never met in person.

My readership is small by comparison. My only revenue comes when my investment conclusions are correct – as they have been on Europe. Collecting revenue whether you are right or wrong is certainly a better business model! I modestly suggest that Mr. Mauldin owes us all an update on Europe. Does he still see a collapse? When? What would be the catalyst?

And he should not complain about policymakers, since that is part of the investment question. If you cannot accurately predict government policies, you are crippled in your investment forecasts.

We do not yet have a final verdict, of course, but those scared out of the market by European fears have clearly missed out. That has been true for US investments, and especially true for Europe itself.

Author: "oldprof"
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Date: Monday, 07 Apr 2014 14:14

Sometimes markets emphasize simple themes, rejecting even modest efforts at nuance. The current big stories are the record highs in stocks, the length of time since the last significant correction, and the "market is rigged" meme. These themes are all easily grasped and interesting media fodder. It has set the agenda.

Meanwhile, the economy seems to be providing a positive answer to early 2014 skepticism – Weather (!) or Not?

The contrast between the economic fundamentals (and impending earnings results) and the "soft" stories will be the dominant theme during the upcoming week.

Prior Theme Recap

In the last installment of WTWA before my vacation, I expected the theme to feature new Fed Chair Janet Yellen in her first press conference. Some might have questioned that forecast, since we had already heard plenty from Yellen both in confirmation hearings and in her "Humphrey-Hawkins" testimony to Congress. What could be new?

The era of Fed transparency yields ever longer statements, economic forecasts, and assurances about future guidance. There are also many speeches. The press conferences by the Fed Chair, given only when the overall forecast has been updated, require extemporaneous answers to questions from financial reporters. It can be a minefield.

In response to question about how long the Fed might delay raising rates after QE ended, she hesitated and said a considerable time. With further pushing she mentioned "six months." This sent stocks into a downward spiral, since there is an over-reaction to any hint of Fed tightening even a modest reduction in the extremely easy Fed policy. Those who have been reading "A Dash" know better than to invest on such reactions, so we had yet another buying opportunity as the clarifications ensued. The theme actually extended over the next ten days.

This all reminded me of Ben Bernanke's first year, when he made a few comments to CNBC's Maria Bartiromo at the White House correspondents' dinner. This is a fun affair, but Bernanke learned that he was not "off the record" and the result was a market-moving story. Bernanke admitted that it was a "lapse in judgment."

This is a perfect 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.

This Week's Theme

In the absence of much fresh news, we can expect another week of pundits on parade. I am calling this fluff versus fundamentals.

On the fluff side I expect to see the following:

  1. More Michael Lewis follow-up stories about rigged markets.
  2. More charts comparing the current bull market with prior crashes. They just keep coming – at least this one has an expiration date!
  3. An assortment of death crosses, complains about volume, and omens.
  4. Any decline in stock prices – even of a few percentage points – as evidence that the "big one" is at hand.

On the fundamental side we have the following:

  1. Spring has changed the outlook. Ed Yardeni notes the rebounding economic indicators and summarizes as follows:

    I have been predicting that the stock market would respond positively to rebounding economic indicators even though everyone knows that some of that strength is simply weather related rather than a sign of economic strength. Nevertheless, investors might have been concerned that the winter's weak numbers might have been fundamentally weak rather than just depressed by the big chill.

  2. Stronger capital expenditures are in prospect. If you read only one thing this week, check out Cardiff Garcia's seven points about capex. His conclusion is a bit cautious, despite the strong evidence:

    We still buy the economic slack argument for why this recovery has room to run, and to run faster than it did last year. But we also recognise that much of the case for an impressive capex pickup could have been made, and by some research teams was made, at the start of last year as well.

The discussion will include some early speculation about Q1 earnings reports.

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

It was a big week for data including plenty of good news.

  • Rail traffic growth is strong. Todd Sullivan notes that it could involve some catching up from weather effects, but the growth is quite large and unusual to see this early in the year. See Todd's post for full discussion and charts.
  • Auto sales are strong, bouncing back more than expected and 81% over the recession lows. Ford F-150 sales, a good indicator for small business and construction, had the highest March total in seven years. See the Bespoke story and their helpful charts. Scott Grannis has a full discussion along with this chart:

  • High frequency indicators were positive. New Deal Democrat covers a wide array of consumption, sentiment and monetary measures in his "spring rebound" account.
  • ISM manufacturing and service reports showed expansion. The levels were not exceptionally strong, but internals showed strength in new orders and employment. (See Steven Hansen at GEI for ISM services and also for manufacturing).
  • Employment news. I am scoring the employment story as positive, even though the indicators – initial claims, ADP private employment, and payroll employment – were all slightly worse than the published expectations. These are all noisy series, so a few thousand less than the consensus guess does not mean much. The results all confirmed the more recent job trends, which were clearly better than the preceding "soft patch." Most importantly, the market treated the results as positive, and that my working definition of good is "market-friendly." For now, good news is good. Here are some highlights:
    • Private job growth has been very solid – enough by itself to reduce the overall unemployment rate;
    • Labor force participation has improved without increasing the unemployment rate;
    • Hours worked has also improved, suggesting more job gains ahead;
    • Improvement in full-time jobs.

    There were a couple of negative aspects to the report:

    • The hourly wage down-ticked by one cent. We need to see wage improvement;
    • The overall level of employment is still disappointing, especially for this point in a recovery;
    • Far too many people are still under-employed.

    The Fed has acknowledged the complexity of the employment news, abandoning the unemployment rate guideline for a more complex picture. Dwaine Van Vuuren has created the "Yellen Dashboard." This will rapidly become the best place to see a summary of what the Fed is considering. Here is the current look, suggesting a tightening in 2016:

     

The Bad

There was also some bad news.

  • Technical indicators are more negative. I always enjoy the market updates from Charles Kirk (small membership fee required), especially his weekly chart show. His objective and flexible approach changes with the evidence and helps traders see what to watch for. Charles notes an uncertain situation with the failure of some bullish setups and a threat to the uptrend. This one-sentence summary cannot do justice to his explanation, so take a look. (Also compare with Felix's insights for traders, below).
  • Investors emphasizing low risk in retirement savings. Putting aside the wisdom of the individual choice, this is a drag on markets. Gallup has poll results showing the emphasis on caution. We should note the sharp contrast with some of the trading-style sentiment polls.
  • Earnings warnings are at near-record levels. According to MarketWatch, there have been negative pre-announcements from 93 out of 111 companies. Here is the key chart:

  • China's growth is slowing. Ed Yardeni has the update on the China PMI data – positive, but lower than expected or hoped for. Here is the key chart:

The Ugly

Middle East peace talks. Some believe that the White House has pulled the plug on Secretary Kerry. (See the CFR story). Whatever the reason, the lack of progress is disappointing.

Humor

We all deserve some laughs. Here is an amusing contrast.

Congressman James P. Moran (D. VA) explains that members of Congress are underpaid at $174,000 per year with assorted benefits and perks. He explains that it is expensive to live in DC. Moran is retiring this year. (Rollcall)

Former Fed Chair Ben Bernanke is raking in the speaking fees. He scored over $250K on his first gig, beating his full-year salary working for the Fed. This seems to be just a starting point. Given the frequency of Bernanke testimony and speeches, I wonder what additional information he has to offer? What sort of incentive structure does this create?

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.

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.

RecessionAlert: Great work on the "Yellen Dashboard" as noted above!

Putting it all together, it is time for another look at the "Big Four" indicators monitored by the NBER when defining recessions. As you look at the chart, remember that a recession starts at a business cycle peak. First we need to see a potential peak, and then there must be a significant decline. Doug Short updates this regularly, providing the best concurrent evidence on the economy:

The Week Ahead

This is a light week for data.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on the most important subject.
  • FOMC minutes (W). After the Yellen press conference and subsequent FedSpeak, what more can we learn? Expect plenty of attention anyway, with a search for nuance.
  • Michigan sentiment (F). This gauge of both spending and employment remains at a crucial level.

The "B List" includes:

  • JOLTS report (T). This misunderstood release is like a "liquidity report" for the job market. Watch the quit rate. It has been high and growing, which is good.
  • PPI (F). Inflation data are still not very interesting.

We will also have some FedSpeak, speeches by assorted foreign leaders and politicians, and some lesser data releases. Tuesday market the "official" start of earnings season with the Alcoa report. In recent years that has been less of a bellwether, so I expect the earnings story to start in earnest next week.

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 into neutral leading us to sell stock positions as more ETFs were sent to the penalty box. This is not a bearish sign, but an indication of extreme uncertainty. By Thursday Felix was completely out of stocks and was 1/3 invested in bonds (via TLT). Those who want to follow Felix more closely can tune it at Scutify.com, where he makes a daily appearance.

Compare this with Charles Kirk's outlook, summarized above.

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 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. Barron's notes that "value stocks" are doing fine.

In our Enhanced Yield program we hardly noticed Friday's selling. Positions declined by less than 0.2%, despite declining stocks and increased volatility on our short calls.

Each week I highlight some of the best advice I see. Here are some highlights.

Bonds beat stocks in Q1. Bespoke has the story with some great charts. This was a surprise for many, including me, but I acknowledge all evidence, and we will continue to monitor this story. I expect the bond to stock rotation to continue.

Morgan Housel has thoughtful comments about expectations and volatility. He writes as follows:

Markets crash all the time. You should, at minimum, expect stocks to fall at least 10% once a year, 20% once every few years, 30% or more once or twice a decade, and 50% or more once or twice during your lifetime. Those who don't understand this will eventually learn it the hard way.

I have frequently written that no one can time the smaller fluctuations. Those who claim success have a standing bearish prediction, claiming success when it works but ignoring years like 2013. I recommend that investors accept the moderate declines as a cost of doing business and try to avoid the bigger moves by using the indicators I report each week. This combination would have caught all of the major declines.

Eric Parnell highlights some risks for those over-emphasizing the dividend growth stocks. Investors perceive an extra measure of safety from dividends and the group has performed well. It is a part of the quest for yield that I have documented, and it has become a crowded trade. It is fine to have a long-term focus on investing, but you should still look for value. Here is one of Eric's charts:

Robert Shiller suggests that most people would benefit from using an investment advisor. (See the WSJ article). Most people misquote and misuse Prof. Shiller by concluding that they should currently be out of the stock market because of his CAPE ratio. In fact, he personally holds an aggressive stock position (for his age) and has consistently recommended that others should hold significant stock positions. He notes that most people do not have the training to pick stocks.

To this advice, I add that most people do not have 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.

If you are missing the stock rally, 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).

And a special thought (and chart) for young investors……from Sam Ro of Business Insider: Study the effect of saving early and consistently!

Final Thought

There are three important themes.

  1. Last week was rich in data and the story confirms the gradual economic progress from the last few years. We seem to have an annual interruption from one cause or another. Each soft patch stimulates another round of recession worries.

    In fact, there has been no sign of a recession for years. As long as we are not close to a business cycle peak, supported by aggressive worldwide central bank policy, we remain in the middle innings of an economic expansion. It is longer than the average because the decline was so great and the recovery is so slow.

    It is a blunder to force the current market into a model of some prior year or the average of past recoveries.

  2. The stress tests deserved more media attention. The featured story was that Citibank (C) had to revise their plan. The big story is that we are doing something more aggressive than in 2008, and that most banks are passing the test. Here is a summary from the WSJ.
  3. The Michael Lewis "market is rigged" story is interesting, but a distraction for investors. I lost count of the number of interviews, starting with 60 Minutes on Sunday night and extending to PBS on Friday. I suppose it will catch the Sunday morning shows as well.

    The most interesting aspect of the story so far is the willingness of the punditry to opine before they have read the book! In some cases, those commenting admit this. In other cases it is obvious that they are just guessing. When a story is breaking, no one wants to take a few hours to collect any evidence.

    I am a Michael Lewis fan and I plan to write a review, just as I did on The Big Short. I have almost finished the book. There are some important worrisome themes to consider, mostly neglected by the reviews so far. I will focus on the implications for long-term investors.

    For now, let me just say that the several years of a "rigged" market have been kind to the thoughtful, informed, and disciplined investor. More to come…..

Author: "oldprof"
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Date: Thursday, 03 Apr 2014 01:05

Here is a happy problem: You have a large instant gain from one of your stocks. What should you do?

The topic comes from an actual question raised at Scutify.com, where participants exchange ideas and get a wide range of opinions. (I get to play the role of the straight man in a world of day traders, revolutionaries, Bitcoin and gold zealots, and bubble callers. It is usually fun and there are some good ideas if you can sort through it all). The stock in question was trading about $4.00 yesterday and doubled in early trading because of a favorable ruling by an FDA Advisory Committee. Since I have nothing to add about the specific company, I am not going to name it. I want to use it as an illustration of how to think about risk and reward. (You can probably guess the stock, but please remember that my upside and downside targets are only illustrative).

For the purpose of this analysis let's assume that the position size is appropriate for the trader or investor in question.

The Standard Answer

Most people would advise something like taking your original money off the table and playing with the "house's money." This gambling metaphor has broad psychological appeal. How would you feel if the stock dropped back nearly to zero?

We know from the behavioral finance literature that people are much more sensitive to losses than to potential gains. The psychology of this situation is powerful.

You could also add that the technical analysts might well be flashing warnings like the following:

  • The stock is trading far above its 200-day (or 50-day or 200-week or X-day) moving average.
  • The stock has a gap opening and the gap "needs to be filled."
  • Or the rally was mostly short-covering with a volume spike.
  • And similar arguments.

The Fundamental Answer

A fundamental analysis starts with a fair value for the stock. In the case of a binary event – the drug is approved or it is not – the calculation is straightforward. Let's do it both before and after the Advisory Committee decision.

I am making up numbers here to illustrate a point. Each case requires good homework. Let us suppose that in the case of success the stock goes to 20. In the case of failure it will go to 50 cents. Next we need to estimate the odds of success. My newest investor program involves many companies with such issues, so I am doing a lot of work on the method. (Examples include companies facing litigation, restating earnings, turnarounds, potential takeovers, as well as new drugs. You would not want a big position in any single name, but a basket can work if you have edge in each case).

Before the Advisory Committee, we might put the odds at 25%. That gives us a "fair value" of 25% times 20 plus 75% times 50 cents, or a value of 5 + 0.375 or 5.38. This was the price of the stock in the weeks before the decision, but it was a premium on the day before. This is what you might expect.

After the Advisory Committee, let us put the odds of final approval at 90%. (Advisory Committees are usually respected). This gives us a value of 20 * .9 plus .5 * .1 = 18.05. The result, which might seem surprising, is that the investment is even more attractive at the higher price, after the decision, than it was before the announcement.

Investment Conclusion

The existing investor should not sell, since edge has increased. A new investor should be happy to join in, even at the higher price. The edge is greater. The fact that the price is higher is irrelevant to the current decision.

I realize that this will seem counter-intuitive to most, but it is exactly what big pharma does in looking for candidates to buy – paying a higher price when the odds of success are greater.

A Caveat on Risk

Remember my earlier comment? Every investor should start by analyzing risk!

If you take on excessive risk, you will make emotional decisions. The insightful investor does a dispassionate analysis of risk and reward – every time, every trade, every day. Find a good system that fits your personal risk profile and stick to it.

Bonus Material

Thoughtful readers might consider how to apply this in other settings. How about the overall market? 2013 saw the removal of lots of risk, starting with the fiscal cliff and proceeding through lower recession chances and better earnings. If you did not buy stocks in 2009 because risk was too high, and you have not increased your holdings since then because you missed the rally, you need to analyze your approach. There must be some combination of risk and reward that is attractive.

If you have not found an appropriate balance of risk and reward to buy stocks in the last five years you are not an investor. You are either a permabear or a pundit!

Author: "oldprof"
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Date: Thursday, 20 Mar 2014 03:43

Regular readers know that I love using sports to find investment insights. There are three reasons:

  1. Plentiful data – both before the event and afterwards;
  2. Specific odds from prediction markets and pundits – even better than we have in stocks;
  3. The comparison forces investors to abandon market preconceptions, thinking about questions in a different way.

What can we learn from the problem of filling out your NCAA bracket?

The Popular NCAA Upset

Investors who listen to the "bracketology pundits" for a few minutes will find it familiar. There are plenty of buzzwords and opinions, but little supporting data.

One popular theme is that you should search for a good upset in your brackets and the best place to start is when the Regional 5-seed plays the 12-seed. There is some logic here. Let's look at the actual a priori odds for these games, taken from the excellent TeamRankings site:

These are the odds of advancing for each round, so the last column is "winning it all."

5     Oklahoma     West     65.3%     34.1%     10.0%     4.2%     1.4%     0.5%

5     Cincinnati     East     61.5%     26.8%     11.6%     5.7%     2.3%     0.9%

5     Saint Louis     MidW     56.8%     14.4%     4.3%     1.6%     0.5%     0.2%

5     VCU         South     69.9%     37.5%     13.3%     6.4%     3.0%     1.2%

Using these percentages, which have proven accurate over time, what is the chance of all four five seeds wining?

That is an easy probability question. It is the product of the four percentages or about 16%. It would be very surprising if we did not see a 12 seed beat a 5 seed. The problem for figuring out your bracket is simple: Which one?

Investment Application

This same probability blunder is a daily feature in investment commentary. Instead of bogging down in the technical definitions, let me just call this backward reasoning. The pundit starts with a conclusion (like the 12 versus 5) and then grabs any single instance as a likely candidate.

To take one of many current examples, let us consider margin debt and market tops. Investors are bombarded with charts showing the history of market tops at times of high margin debt, implying that this is a high-risk factor. Try putting the question the other way:

In all of the occasions where margin debt reached a peak, what were the investment results? Bespoke Investment Group (via Jeff Saut and Raymond James) provide the results:

Conclusion

The popular margin debt meme is yet another misleading argument, a trap for investors who do not understand how to analyze causality. Here is an investment tip to save money:

Ignore the advice about margin debt. Make your decision on stock allocation based upon your personal circumstances. If you want to speculate on bad advice, just pick all of the twelve seeds in your bracket!

Author: "oldprof"
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Date: Sunday, 16 Mar 2014 03:05

Rightly or wrongly, markets continue the Fed fixation. Many expect (or demand?) a change in Fed policy. This week marks the first FOMC meeting with Janet Yellen as the Chair. Since there will also be an update to forecasts, the announcement will include a press conference. With some fresh data and plenty of news since the last meeting, my theme for this week:

Fed Chair Yellen will take center stage.

Last Week's Theme Recap

I expected last week's theme (in the absence of much real data) to be focused on a parade of pontificating pundits. That was very accurate. As predicted, there were many articles of the laundry list type. That is where the pundit or journalist starts with a scary theme that can be expected to be popular and then looks back to find some similarities with the past. What a joke! Suppose you had a group of summer interns. Ask them to take any year in history and read newspapers, listing anything that is similar to current times. They will deliver.

Most people have a low bar for research findings, particularly when it suits their own conclusions.

This is a perfect 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.

This Week's Theme

How should we get ready for this week's Fed announcement? There are three basic positions:

  1. Rate hikes might come faster than expected. This is for one of two main reasons:
    1. Lower labor force participation (Matthew Boesler at BI).
    2. Lower growth potential (Morgan Stanley's Vince Reinhart via Joe Weisenthal).
  2. There is plenty of labor slack from cyclical forces, suggesting the need for patience. Fed expert par excellence Tim Duy explains in a thoughtful article with many charts. It defies summary, so those who want to understand need to read it.
  3. Status quo. See Chicago Fed President Charles Evans. (Via Reuters).

We will probably start the week with breaking news from Ukraine, but by Wednesday our focus will, once again, be on the Fed.

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

In a light week for data, there was some good news.

  • Earnings growth remains solid – both reported and forecast. The last quarter of 2013 approached the 10% growth predicted by Brian Gilmartin and few others. In Brian's most recent update he highlights the three time frames you should use when thinking about earnings growth:
  1. The quarter being reported, i.e. q4 '13, is very robust. Hard to argue with +9.8% y/y earnings growth;
  2. The quarter within which we currently reside, which starts getting reported early April '14. Current consensus estimate of +2%, will likely decline over the next 3 weeks, and then by mid-May, once the majority of companies report, we will likely end up between 4% – 5%, maybe better;
  3. Full-year '14, which like q1 '14 has been impacted by weather. I think the 2nd half of '14 will be stronger than the first half of '14.
  • Retail sales beat expectations with a gain of 0.3% and 1.5% YoY. The monthly result was less impressive when considering revisions to the prior months. Calculated Risk notes that the YoY gain is 2.2% if you exclude gasoline sales. Doug Short has a great chart package. This one shows why the most recent update is (perhaps) not so exciting:

  • The number of US millionaires is at a new high – 9.63 million versus 9.2 million in 2007. (LA Times).
  • Initial jobless claims hit a new low – 315,000. It is a noisy series, but this is encouraging.
  • Job turnover data remains positive. It was in line with expectations, but as Calculated Risk notes, it confirms a positive trend. The two things to watch are job openings and the quit rate (higher quits are very positive). You can see both from this chart:

The Bad

There was also some bad news.

  • High frequency indicators continue to be weaker. I always read carefully the fine weekly summary from New Deal Democrat. He collects many concurrent indicators that each might seem minor, but collectively are quite significant. He documents a continuing overall soft patch.
  • Copper prices are in a dramatic decline. The market seems to be reacting to this news. Some even infer a global recession from the recent message from "Dr. Copper." The current pricing is heavily influenced by China – important, but not necessarily the only global factor. Dr. Ed prefers the CRB to copper, and discusses other factors as well. Here is the Yardeni chart:

  • More Americans see Russia as a threat – 69% according to a CNN poll. 40% also fear a nuclear war with Russia. (If you share this fear, how should you invest? Answer in the conclusion.)
  • Michigan sentiment disappointed. I regard this as an important indicator for both employment and consumption. It is time for a fresh look at my favorite chart of this data series, one that combines the history, GDP, recessions, and the average level. Naturally, it is from Doug Short.

  • Ukraine developments. Regardless of one's interpretation of events, the market will definitely interpret added tensions as negative. Stories about troop movements to the Crimean border will definitely rile the markets. As has been the case for the last two weeks, anything I write can be obsolete by the time you read it. Separate your interest as a citizen from your decisions as an investor. I have heard several stories about people who sold all of their stocks because of these events. In addition to the excellent sources I have provided over the last two weeks, I recommend this article by William A. Watts of MarketWatch. It emphasizes the investment perspective. I love the comment from my friend and colleague Scott Rothbort, who writes a daily "Gut Feeling" column on the markets: This is a game of chess, not battleship.

The Ugly

9/11 planner released in a prisoner swap – now moved to Germany where the statute of limitations on terrorism is ten years. (Full story at The XX Committee).

Humor

We all deserve some laughs. Some of the most popular blog posts provide the humor that lends perspective to what is happening.

Bespoke's premium service analyzed the over-reaction to small market moves (via Dorsey Wright).

And Josh Brown's list of "explanations" for Thursday's selling was a big hit. Check out his full list, but here are my favorites:

Fox Business: Obamacare

CNBC: It didn't sell off at all, it was actually a reverse rally

Forbes: Taxes are too high

Huffington Post: Taxes are too low

Fox News: Gay marriage

Motley Fool: Sign up here to find out!

Bloomberg TV: The opposite of whatever CNBC said.

StockTwits: Here's a chart

USA Today: Let's take a poll

Zero Hedge: Better question, why would it have gone up?

Business Insider: Ten reasons, actually (view as single page?)

Financial Times: Please take a moment to register and accept cookies

MarketWatch: 1929

If you are a regular reader of these sources, you will be laughing.

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 newest recession indicator, maintaining an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time. Georg's BCI index also shows no recession in sight. For those interested in gold, Georg also sees a possible buy signal next month. Stay tuned!

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

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, you should be reading this update.

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." None so far – and Bob has been far more accurate than the high-profile punditry.

David Rosenberg's indicators suggest no recession and probably two more years of growth. His analysis will sound familiar to our regular readers, since it has been our message for almost three years:

For Rosenberg, the central question is whether the U.S. economy will relapse into a recession. Once you answer that question, he said, you can debate the direction of the equity and fixed-income markets.

The U.S. economy is incredibly resilient, he said, and he agreed with the adage that a recovery never "dies of old age."  It takes a "negative shock" to start a recession, he said - "and those always have the Fed's thumbprint on them."

A severe foreign-based shock is unlikely to derail U.S. growth, he said. Rosenberg noted that our economy and markets had good performance following the Asian crisis in 1997.

The Week Ahead

After a week of light data, this week is more normal.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on the most important subject. Confirmation for new lows?
  • Housing starts and building permits (T). Housing could be an economic driver. These are leading indicators.
  • Industrial production (M). February data for a key GDP component.

The "B List" includes:

  • Existing home sales (Th). Less important than new construction, but still a good measure.
  • Leading indicators (Th). Still widely followed.
  • CPI (T). With no signs of inflation, this remains a secondary indicator.
  • Fed stress test results (Th – after the close). Some background here.

The FOMC announcement on Wednesday followed by Yellen's first press conference will be the big event for the week. I am less interested in the regional Fed results.

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

Three weeks ago Felix made a dramatic switch from neutral to bullish adding trading positions throughout the week. That has worked pretty well. We remain fully invested. Many sectors have returned to the penalty box, reflecting reduced overall confidence in the three-week forecast.

It has been tougher than ever for traders, and that is saying a lot. This Taiwan Stock Exchange study says that "Less than 1% of the day trader population is able to predictably and reliably earn positive abnormal returns net of fees."

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 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.

Each week I highlight some of the best advice I see. Here are some highlights.

Eddy Elfenbein has a typically level-headed analysis about what long-term investors can expect from stocks: 5% in real terms, half from capital appreciation and half from dividends. If you expect some inflation, you need to add that. Stocks are a good inflation-fighter. Read the full post for comparisons with some recent bearish arguments. If you are a good picker of stocks, you might add a little to that.

Value Line's famous strategist, Sam Eisentadt, sees another 12% in stocks before September. No guarantees of course, but he asks if anyone has a method with a better track record for six-month changes. (Via Mark Hulbert).

Barry Ritholtz addresses the issue: How Market Tops Get Made

This is a good analysis of key factors developed over decades of research, so read about each. Here is a key quote:

What does all this mean for the current run? According to Lowry's, "the weight of evidence continues to suggest a healthy primary uptrend with no end in sight." For those concerned with a market top, that is rather bullish.

A few caveats about Desmond's studies: Although he is rigorous and empirically driven, these data points all come from past market behavior. There are no guarantees that in the future, markets -- that means you, Humans -- will continue to operate the same way. Perhaps the changing structure of markets might impact market internals. Maybe the rise of ETFs will have an impact. Regardless, there are no guarantees the bull will continue.

However, based on the data Desmond follows, he makes a fairly convincing case that this bull market still has a ways to go before it tops out.

Steven Russolillo of the WSJ takes on the same topic with a checklist from Strategas Research Partners:

 

 

Why choose these sources to highlight? Integrity. Using indicators that have worked for years. This is in sharp contrast to those who start with a viewpoint and switch whenever the indicator no longer works. In a continuing exercise in futility, I wrote about this topic last week here and here. Most people would prefer to be scared witless (TM OldProf). Which leads to…..

 

And finally, most Americans have missed the rally – so far—according to Bloomberg. If that describes you, you have 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 am well aware of the difference between perceptions and reality. The former is of greater interest to traders. Many of them have been caught off base (switching metaphors for the new season) and blame the Fed for their own mistakes. (See Fed as a Fig Leaf).

The reality is that the current QE rendition is having only a small economic effect and it will matter little when it goes. (See my QE summary.)

One of my regular themes is the over-emphasis on the Fed rather than economic fundamentals --- earnings, recession risk, and potential financial stress. That focus will pay off for long-term investors.

Quiz Answer

Too easy, perhaps, but the answer comes from Art Cashin. He was a trainee during the Cuban Missile Crisis (1962). I remember reading the story nearly thirty years ago – and it was old then!! (See Paul Vigna). You might as well buy, since if they don't find a solution, it won't matter!

Author: "oldprof"
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Date: Wednesday, 12 Mar 2014 01:07

Yesterday I wrote about sources that simply dropped an indicator when it no longer fit the pre-conceived thesis. Sometimes it is even more blatant dramatic.

Some sources simply engage in fancy footwork, reversing their rationale, confident that their uncritical followers will not notice or care.

TODAY

I always read MarketWatch. In the midst of many current warnings about the Fed being behind the curve in the face of incipient wage inflation, I was confronted with the following headline:

Are you ready for deflation?

Writes Brett Arends at MarketWatch.

He bases his analysis on the work of Albert Edwards, as follows:

The market-based PCE, says the Commerce Department's Bureau of Economic Analysis, is "based on market transactions for which there are corresponding price measures." That means, the Bureau adds, that the market-based PCE "provides a measure of the prices paid by persons for domestic purchases of goods and services."

Some of us thought that was the definition of inflation. The market-based PCE, observes Albert Edwards, chief global strategist at SG Securities, "excludes prices which the statisticians have to invent!"

Edwards, in a new research note, points out that this purely fact-based inflation indicator is undershooting the better known ones, such as the regular PCE and the CPI. And, he adds, it is undershooting by more and more.

Albert Edwards? Really?

Wasn't he the one who saw hyperinflation coming? Let's check the Wayback machine!!

April, 2013

The message was quite different last year….

ALBERT EDWARDS: Stocks Will Crash, Hyperinflation Will Come, And Gold Will Go Above $10,000


Joe Weisenthal reported the facts, but his skepticism was clear.

 

The Fact: "We still forecast 450 S&P, sub-1% US 10y yields, and gold above $10,000."

And also, "We have written previously, quoting Marc Faber, that "The Fed Will Destroy the World" through their money printing. Rapid inflation surely beckons."

Joe's comment: So yeah, it goes on from there. Lots of doom. This is why everyone loves Albert Edwards.

Investment Conclusion

It is so popular to criticize the Fed and to predict doom that the uncritical audience laps it up. Few readers track the prior failed predictions.

Meanwhile, formerly bearish analysts who dare to change their views come under criticism. Please contrast this example with the case of David Rosenberg, who caught flack for paying attention to changing facts. Barry Ritholtz had a great discussion here.

When I read investment commentary involving the Fed, I see a rather clear distinction among three camps:

  1. Some disliked Fed policy from the start. They disagreed, predicted that it would not work, and disparaged the FOMC both individual and collectively. Their forecasts were wrong. If you followed them, you lost money.
  2. Some liked Fed policy. They were optimistic about the consequences and (perhaps) exaggerated the impact. They praised the Fed leadership.
  3. The pragmatists. They accepted the reality of who was in power, not "fighting the Fed." This has been the most profitable perspective for investors – accepting the policy decisions and the likely outcomes.

The Fed has become a lightning rod for economic debate. Whether you were zapped or protected depended greatly on your skill at dodging confirmation bias -- consuming information wisely and rejecting pundits who were locked into their paying audience.

Author: "oldprof"
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Date: Tuesday, 11 Mar 2014 01:44

Objectivity!

One of the most important questions for consumers of punditry is whether the source is intellectually honest about methods and interpretation. The test is a simple one:

  1. If an indicator is cited as support for a market position, take note.
  2. If the observer decides to change indicators, there should be a logical explanation – best done when it is not an excuse for maintaining current viewpoints.
  3. If the indicator is dropped when it no longer supports the pre-conceived viewpoint, be warned!

Since I read widely from many sources, I am often intrigued by provocative claims. If you want to challenge your own biases, you must be willing to see an opposing viewpoint. If you learn that a source has turned a blind eye that should be a red flag.

Two Examples

Case one. There has been a lot of recent buzz about high levels of margin at the NYSE. For a time, your favorite conspiracy site insisted that this had nothing to do with short interest, since that was declining as the S&P was rising. Here was the chart:

Let us now compare with more recent data via CNBC:

It is pretty obvious that the ZH post coincided with the one big diversion in this series. Do not hold your breath waiting for an update!

Case two. A famous pundit who is generally bearish identified an interesting indicator – purchase of dental services. The basic idea was that many dental procedures were discretionary and therefore a great real-time indicator of consumer strength. Since I admire the source and his ability to find innovative ideas, I thought this was quite interesting. I put the key stock, which he recommended as a short, on my quote screen. One of his several public comments (and not the first) was in mid-2012 when he noted that the stock was at an all-time high. Here is the stock chart:

 

We can see that the stock is up 50% since the time of this widely-publicized article. You probably did not short it, and neither did I. Our hero (no doubt) had a nice stop on his short. That is not the point.

What about the status of this great, little-noted indicator? Has something happened so that the "discretionary" dental purchases are not a good indication? Maybe there was an explanation that I missed, but it seems like just another discarded indicator. Meanwhile, the pundit continues to write daily about headwinds and new reasons to short the market. How about an explanation of what has changed about discretionary dental expenditures?

How Investors Can Use this Concept

It is pretty simple. Make some notes about the reasoning – not just the conclusions – of your favorite sources. Look at the indicators and specific forecasts.

It is perfectly acceptable to change your mind about an indicator. In my weekly updates I am quite clear about what is important and what is not. If there is a change, I explain it. This is the standard that you should expect.

There are dozens of similar examples. I invite nominations from readers.

Author: "oldprof"
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Date: Sunday, 09 Mar 2014 06:28

With stocks hitting new highs and the bull market reaching age five, the potential for a market top is a popular subject. There is a light schedule of economic releases, so pundits will be free to spend nearly full time explaining the rally and offering their forecasts.

Expect even more articles like "Six reasons this is a market top" and "How to protect your portfolio."

I could get more page views with a title like that, but let us try to put this more neutrally and make it forecast-free:

What is the risk/reward for stocks?

Last Week's Theme Recap

I expected last week's theme to be focused on employment and that was mostly correct. I also noted that there would be continuing attention on the Ukraine situation, with events changing rapidly. The market was reacting to the potential for armed conflict. I provided several balanced sources to help your assessment of events, concluding as follows:

If you are too lazy to read these brief and helpful articles, here is the one-sentence summary: We are very distant from a US/Russia armed conflict. There are umpteen diplomatic steps along the way, starting with skipping a planned trip to Sochi.

This is a perfect 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.

This Week's Theme

How should we evaluate the overall market risk and reward? There are three basic positions:

  1. Skeptics and top-callers. Stocks are over-valued, supported only by the Fed. Compare to what happened when stocks visited these levels before. The cycle is extended and overdue for a correction. This article is typical of many.
  2. Reasonable valuation. Modest growth has supported the market ascent. Stocks are fairly priced and can continue single-digit growth if sales and earnings keep pace. Josh Brown cites distinctions between now and 2007.
  3. Bullish prospects. The economic cycle has not yet reached trend levels. A rebound in economic growth could spark a strong second half to 2014. Some even worry about a melt-up, with both increased earnings and multiples.

No one can make a confident forecast for the next market move, but it may be possible to define some limits. 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 good news.

  • Eurozone PMIs are improving. Hale Stewart reports on the Markit index at 53.0 and above the earlier flash estimate. I am still cautious about the interpretation of these reports. I suspect that a sharp journalist will soon make a deep dive into the methodology. There is definitely a market impact, reflected in overnight futures. We care about Europe, but is this the best measure. (Same question for China).
  • Bullish sentiment (a contrarian indicator) is still low. Our favorite chart of this via Bespoke:

  • ISM manufacturing beat expectations, signaling expansion with a reading of 53.2. Steven Hansen at GEI has a comprehensive analysis. Read his full story for charts, comparisons with regional Fed surveys, and discussion of the component categories. It is a comprehensive look at an important report.
  • The PCE price index is up only 1.18% year-over-year. This is the measure of inflation watched by the Fed, with a target of 2% and a willingness for a temporary increase at a higher level. If you want to profit through understanding the Fed, you had better start with following the PCE. Doug Short has the analysis and charts we have grown to expect, including this one:

  • Americans are richer than ever. US household assets increased by $9.8 trillion or 14%. Scott Grannis has the story and also several charts. This one shows that we are almost back to trend growth:

  • Four million properties returned to positive equity in 2013. CoreLogic data via Calculated Risk.
  • The Fed's Beige Book shows modest growth. Calculated Risk has a great analysis, noting the regional differentials and weather effects. Scott Grannis explains why modest growth has been working just fine for stocks. (Chart lovers should check this out).
  • Personal spending increased 0.4%, beating expectations.
  • Employment growth was mixed, but generally a market positive. It was better than expected on several fronts
    • Payroll growth showed 175K net gain in jobs.
    • Labor force participation increased.
    • Higher unemployment rate is probably a more accurate reflection of reality and gives the Fed a little room to remain aggressive.
    • State governments are no longer a source of job losses. (WSJ analysis and charts).
    • Initial jobless claims declined 26K, back to the bottom of the range.

    Matt Phillips at Quartz has a great chart package. Here are two of special interest, showing weather effects and the decline in involuntary part-time employment (still a problem, but much better).

 

The Bad

There was also some bad news.

  • High frequency indicators are weaker. I always read carefully the fine weekly summary from New Deal Democrat. He collects many concurrent indicators that each might seem minor, but collectively are quite significant. There is an overall soft patch. Weather?
  • Auto sales were weak. Another weather effect? Any catching up in the Spring?
  • Private job growth was modest -- only 139K as reported by ADP. Since I view this report as a useful independent read on employment growth, I treat it with respect.
  • Ukraine. The conflict continues, with potential impact on trade and energy prices, but far from the much-feared military effects. George Friedman of Stratfor (Courtesy GEI) has an excellent background piece with some thoughtful ideas about the future.
  • China PMI fell to 48.5, in line with expectations, but showing contraction. This is sending copper prices, viewed by many as a general economic indicator, to the biggest decline in over two years. (WSJ).
  • ISM services was very weak at 51.6. While still indicating expansion, it was the lowest reading since 2010, as shown in this chart from Bespoke:

  • Margin debt hit an all-time high. Doug Short has the story and great charts. This is widely viewed as a market negative, but I wonder. It seems to be a concurrent indicator and it applies equally to those buying stocks and those selling short. Either way, there can be margin calls when big moves take place.

The Ugly

The Pentagon – spending $300,000 per year to study body language of world leaders like Putin. Apparently realizing that people might find this to be an unreliable method, the Pentagon press secretary Rear Adm. John Kirby "did his best to distance them from Defense Secretary Hagel's office, stating, "The secretary has not read these reports. And I don't believe that — I can tell you for sure that they have not informed any policy decisions by the Department of Defense."

So we are spending for information that is not being used. Also, the information is not classified but also not available to the public. (The Hill).

Noteworthy

Late Friday afternoon CNBC announced that Larry Kudlow was retiring from his regular evening show, a staple of the network's evening programming for nearly a decade. Other sources suggested that he was pushed out because of declining ratings. Some have complained about his optimistic views on the stock market and the economy.

There is a lot of tension in a program that combines politics, the economy, and financial markets. I suspect that I have viewed as many episodes as anyone over the years, often citing what I saw in my regular posts. I record each episode (and also the PBS Newshour) and watch them both via TIVO every night. I fast forward through segments of less interest. Over the years, I have found that I have skipped more of the politics and focused on the interesting market debates.

It is distressing that many critics see the exact opposite in the strengths and weaknesses. Some complain that Kudlow sought effective responses to bearish pundits like Peter Schiff and Michael Pento. This is a lame argument, mostly because the show sought effective debate. It is difficult for anyone to engage aggressive participants who do not play nicely – interrupting and talking over your points.

It is also interesting that these complaints come even though Kudlow has been correct on both the economy and the markets. Political conservatives who listened to him did much better than those who followed his critics.

I note that another CNBC alum, Maria Bartiromo, bemoans the political talking points and wants to provide better grounding for investors. This is exactly what is needed, but it does not score in the ratings. We will all watch with interest as she attempts to reach this goal.

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 newest recession indicator, maintaining an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time. For those interested in gold, Georg also sees a possible buy signal next month. Stay tuned!

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

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, you should be reading this update. Doug also has updated the big four indicators important to the NBER in recession dating. Everything except employment is showing a decline – small so far. This is the single best summary of concurrent indicators, so join me in watching it closely. Here is the updated chart:

  • 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." None so far – and Bob has been far more accurate than the high-profile punditry. See also a good yield spread article via Barry Ritholtz, part of Bob's method.

The Week Ahead

This is a very light week for data.

The "A List" includes the following:

  • Initial jobless claims (Th). Best concurrent read on the most important subject.
  • Michigan sentiment (F). Crucial for consumer spending and as a read on jobs.
  • Retail sales (W). February data, so the weather debate will continue.

The "B List" includes:

  • JOLTS report (M). Labor turnover is getting more attention, but most use it incorrectly. Do not try to "back into" some job creation estimate from this. Other methods are better. Look at the quit rate and job vacancies.
  • PPI (F). Inflation will be a factor someday, but not yet.

There will be some FedSpeak, including Vice-Chair nominee Stanley Fischer on Friday.

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

Three weeks ago Felix made a dramatic switch from neutral to bullish adding trading positions throughout the week. That has worked pretty well. We remain fully invested. Most sectors have emerged from the penalty box, reflecting greater overall confidence in the three-week forecast.

In case you missed it last week, I want to highlight the return to blogging of my friend and former Naperville resident, Brett Steenbarger. There is plenty of good fresh content on his blog, but I especially like the post on Ted Williams and the need to pick your spots.

This was also one of my themes back in 2008, when I posted the same chart of Ted and his strike zone. It is a concept behind our Felix model and the penalty box, but it can readily be applied for investors with a longer time frame.

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. I did this for my clients last Monday.

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 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.

Each week I highlight some of the best advice I see. Here are some highlights.

Warren Buffett continues to grab the headlines, and we are happy to glean what we can. Most people probably did not see his early-morning appearance on CNBC, covering many interesting topics: Ukraine (he was ready to buy), Stock market rigged? (No), his will (Stocks, with a little cash for needed expenses), and some specific stock advice. Great stuff from Brooklyn Investor.

 

See also David Merkel's nice treatment of intrinsic value – a deep dive into the annual report that you will not get anywhere else.

 

Barry Ritholtz emphasizes the importance of process versus outcome. I see this frequently, as investors talk about what has worked recently without analyzing why. Here is a key quote:

 

Outcome is simply the final score: Who won the game; what numbers came up in a roll of the dice; how high did a stock go. Outcome is the result, regardless of the method used to achieve it. It is not controllable. You can blow on the dice all you want, but whether they come up "seven" is still a function of random luck.

Process, on the other hand, is a specific methodology. It is a repeatable approach to any challenge or endeavor, be it construction or medicine or investing. And you can control a process.

What kind of people are outcome-oriented? Gamblers, many (but not all) sports fans and, of course, speculators.

What about the process-oriented people? They include airline pilots, professional sports coaches and, of course, long-term investors.

 

 

And finally, many investors are sitting in cash (Yahoo Finance). This is one of the problems where we can help. 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

Most of the arguments comparing current markets to past tops rely heavily on anecdotal evidence of the infamous charts that try to match up prior times by distorting the scales. It is easy to find similarities between now and any point in history – both good and bad. It is a method that starts with a conclusion and then looks for "evidence." People should know better, but such analogies are difficult to refute and persuasive to those who want to believe.

Downside risk is greatest when there is a recession or a financial crisis. Both risks are extremely low. Even without much growth investors can profit from a sideways market, as I have frequently explained.

There is little discussion about upside potential. Even modest forecasts draw scoffing from the peanut gallery. A few weeks ago Laszlo Birinyi predicted that the S&P 500 could rebound to 1900 by July. His most recent report notes that all of the comments on his article were negative. No wonder the media cater to the scare pieces.

Meanwhile, it is easy to imagine more upside. If the economy strengthens in the second half of the year, there will be less skepticism about the current 2014 S&P earnings of almost $119. The forward earnings yield of 6.33% is an attractive alternative to bonds. (Data but not conclusion from Brian Gilmartin's excellent weekly earnings update). Stir in a little improvement in sentiment and you get forecasts like that of JP Morgan's Thomas Lee – Up 20% for the year with a 1 in 3 chance of a 30% gain.

Many observers cite the slow economic recovery without realizing the implication: This is a longer and slower business cycle. Trying to call a market top based upon average cycle length is an error that everyone is itching to make.

Risk and reward are not as negative as most seem to think.

Author: "oldprof"
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Date: Sunday, 02 Mar 2014 03:47

Employment remains the paramount concern – for the economy, for the Fed, and for financial markets.

There are many employment indicators, but that can be more confusing than helpful. Rarely is there a consistent picture.

Can we find more clarity about employment?

Last Week's Theme Recap

I expected last week's theme to be focused on housing. That was basically correct. While I cited the Ukraine situation in the week's "ugly" award, it was a bigger topic of discussion than I expected. I teed up Calculated Risk and NDD for the housing debate. They have a charitable bet, which CR will win if starts or sales are up 20% YoY in any month during 2014. That is a pretty clean definition. NDD has the first update.

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.

This Week's Theme

The market has been rather forgiving about some weaker economic data. This has been especially true of the jobs situation, where the rate of growth has seemingly changed.

There are several important employment themes.

  • Has the growth rate slowed? How much might be attributed to the weather? This will be a main theme in the week ahead.
  • What about the end of extended unemployment benefits? This topic is mired in competing studies, celebrated by various viewpoints.
  • Seasonal and weather effects complicate data interpretation.
  • Differing methods, each with some validity, permit political spin potential.
  • Ed Yardeni notes that the consumer confidence internals show more confidence about employment.

 

As always, 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 a little good news and some that was "less bad" than expected. Because of this, the tilt seems a little bullish, which I do not really mean. It was a week of "neutral is good." You might disagree with my scoring!

  • An interesting array of unusual indicators are positive. Divorce rates? College attendance? These are not what you would expect but all five are quite plausible. (Rick Newman at Yahoo Finance).
  • New Deal Democrat cites improving high frequency indicators. Since he is objective and solidly grounded in the data, we should pay attention.
  • Consumer confidence held up. I am calling this a positive since declines were expected. There is a nice account by Kathleen Madigan at the WSJ. See also my favorite Doug Short chart.
  • Short interest is spiking. Ryan Detrick notes that not everyone is bullish. Here is the key chart:

  • Sentiment is more bearish a contrarian indicator. Bespoke has the story and their typically great chart.

  • Earnings growth is still solid. Brian Gilmartin has (yet another) nice piece where he looks at changes in forward earnings, the Fed model, and the equity risk premium. He discusses 2008 – comparable to current valuations – and notes that there were some different factors involved. His conclusion: "Like the good lawyer once answered, when asked about whether the SP 500 is overvalued or undervalued, "I can argue it either way". CNBC also notes the bullish late-year forecasts.
  • Durable goods orders were down, but better than expected given the weather. Doug Short has a nice account.

 

The Bad

There was also some bad news.

  • GDP was revised lower, to an annualized rate of 2.4%. I am scoring this as a negative, despite my last week's warning that this is old news and not very relevant. The below trend growth story continues. The WSJ surveys economists who conclude "nothing new" and even a small positive from inventories. Doug Short's chart helps us to see the component contributions:

  • Housing data disappointed. The headline numbers were OK, but I am not placing much confidence in the 9.6% increase in new home sales (despite the market reaction). Calculated Risk warns about relying on the headline number. John Lounsbury and Steven Hansen look at the story without the seasonal adjustments – especially difficult to do accurately right now.
  • The Ukraine situation remains a big concern. The usual suspects feed a constant stream of commentary and videos. We live in a world of information without context. The events are clearly a market negative, especially in Friday's trading. The "hot money" traders are cautious in front of a weekend. Anything that I write could be obsolete before you read it. There are many good sources for a balanced account of events. I recommend those that are not trying to sell you fear and gold. You can get some good background from the Bloomberg team and with a specific investor orientation from William Watts of MarketWatch. If you are too lazy to read these brief and helpful articles, here is the one-sentence summary: We are very distant from a US/Russia armed conflict. There are umpteen diplomatic steps along the way, starting with skipping a planned trip to Sochi.

The Ugly

Stock trading by SEC employees. Their buying looks like that of the average investor, but sales occur before enforcement actions. That is usually good timing! The SEC responds that the trades were approved in advance by their ethics office, and that employees were required to sell positions when they were working on an enforcement action. (The Washington Post has good coverage of this story).

This is an explanation? That your job not only permits but requires trades based upon inside information? The monitoring program has apparently only been in effect since 2009.

SEC employees should not have investments in individual stocks. How can we otherwise maintain public confidence?

Ukraine. Of course. There is breaking news as I write this. It is an important human story and another chapter in the changing nature of governments around the world. I know that some want to make any conflict into a market story. We can be sympathetic without politicizing our investments. There does seem to be some market reaction to developments, but that should not be our main theme.

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!

This week's award goes to Scott Grannis, who refutes the scary headlines from the usual suspects. They say that the Chinese currency is "plunging" and shows the biggest single weekly loss ever. People seem to love reading this stuff, since they have made these sources the most popular. We love to have our biases confirmed!

Here is the needed perspective:

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 newest recession indicator, maintaining an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time. For those interested in gold, Georg also sees a possible buy signal next month. Stay tuned!

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

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, you should be reading this update. Doug also has updated the big four indicators important to the NBER in recession dating. Everything except employment is showing a decline – small so far. This is the single best summary of concurrent indicators, so join me in watching it closely. His work is consistent with the most recent ECRI update.

Scott Grannis also has an update of the Bloomberg Financial Conditions Index. I prefer the choices in my weekly table, but there is usually solid confirmation from sources like this.

The Week Ahead

This is a very big week for data.

The "A List" includes the following:

  • Employment report (F). More important than ever and difficult to interpret.
  • ISM index (M). Important concurrent indicator includes some leading components.
  • Personal income and spending (M). Can consumers keep spending?
  • Initial jobless claims (Th). Not linked to the Friday report, but still important.
  • Fed beige book (W). Anecdotal information, but important color for the next FOMC decision.

The "B List" includes:

  • ISM services (W). Growing in significance
  • ADP employment report (W). A different method from the BLS and probably just as good. Widely misunderstood.
  • Auto sales (W). February data of great interest? Weather effects?
  • PCE prices (M). The Fed's preferred measure.
  • Trade balance (F). Relevant for Q1 GDP.
  • Construction spending (M). January data, but an important economic component.

There will be plenty of FedSpeak, especially on Thursday. Until some stability is reached, the Ukraine news will compete for attention with the economic data.

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

Two weeks ago Felix made a dramatic switch from neutral to bullish adding trading positions throughout the week. That has worked pretty well. We remain fully invested and there are many sectors emerging from the penalty box. It has been a challenging few weeks for traders. Felix does not anticipate market tops and bottoms, but managed to adjust pretty quickly both to the correction and the rebound.

Traders can all learn from my friend, Brett Steenbarger, who has resumed blogging. You can start with "Being Your Own Trading Coach" but there is plenty of great recent content.

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 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.

Each week I highlight some of the best advice I see.

Warren Buffett's annual shareholder letter is always a must-read for investors. We had a few "preview items" last week, but there is plenty more in the full letter. Here are some points I found to be especially helpful:

  • Focus on the future productivity of the asset you are considering. If you don't feel comfortable making a rough estimate of the asset's future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn't necessary; you only need to understand the actions you undertake.

 

  • If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.

 

  • Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.

 

 

And especially…..

 

  • Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle's scathing comment: "You don't know how easy this game is until you get into that broadcasting booth.")

Read the full letter here.

The most hated rally continues.

 

Joe Fahmy writes that People Still Hate The Stock Market. He covers the entire story of top-calling and market valuation. Here is a key quote:

 

On the retail side, I talk to AT LEAST 2 potential clients every month who refuse to invest in the market because "we are at a top." It's been like this for the past 18 months! The pain from 2008 has left deep-rooted scars in the psychology of individual investors.

 

Ryan Detrick has an interesting take on the potential for future market gains – another fifteen years. He is amazed that some are calling this a secular bear market, providing this chart:

 

 

Many investors are sitting in cash (Yahoo Finance). This is one of the problems where we can help. 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 market continues to show resilience. It is important to understand key economic elements which relate to earnings. Employment is a keystone.

I want to repeat a recommendation from last week. Since my regular report did not go out until Monday (I try, but I cannot always maintain the schedule) it did not have the regular readership. If you read a single thing about employment, this will provide the needed perspective.

Matt Busigin has a first-rate analysis of the employment situation, covering many topics with special insight and better use of data. I have followed employment data carefully for many years and I am not easily impressed. This is really good! He covers plenty of news you can use:

  • Household versus payroll surveys – the picture is better than we think
  • The reality of labor force participation
  • We only need job growth of 67K per month to maintain the current unemployment rate
  • How much unemployment is structural
  • Could the Fed respond to a tight labor market faster? Much faster…

In addition, I note that Mark Zandi sees the immediate unemployment compensation effects as a reduction of about 0.15% of GDP. There will be more to come as another 1.9 million people lose benefits.

Readers should make their own choices about this as citizens and as voters. In our investment role we must be dispassionate analysts of the economic effects.

Author: "oldprof"
Send by mail Print  Save  Delicious 
Date: Tuesday, 25 Feb 2014 03:11

Housing data have clearly hit a soft patch. How much of the deceleration is important? How much can be attributed to weather?

Most importantly: Does weakness in housing threaten the economic recovery? What does it mean for stocks?

[note to readers. I always try for weekend publication, but sometimes I cannot work then. The links and ideas this week were so important and still timely that I decided to finish writing this evening.]

Last Week's Theme Recap

I expected last week's theme to be focused on the market rebound. That was basically correct. I failed to guess that the (delayed) Fed transcripts would finally be released, providing a pundit's dream. It was open season, as everyone went wild using information that they know now to show how stupid the Fed was five years ago.

The weather story continues. We await a "clean" read on data. Until then we are guessing how much is temporary, what sales have been permanently lost, and what has been "pushed forward."

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.

This Week's Theme

The market rebound in the face of weak economic data continues to challenge the punditry. The recent improvement in earnings now seems like ancient history, with renewed focus on yet another "soft patch" in economic data. Some will attribute this to the weather, but that explanation (excuse?) can only persist for another month of reports.

Last week's housing weakness is a continuing theme. There are two basic positions, illustrated by objective sources who are open to new information:

  • The pessimist is New Deal Democrat. While remaining open-minded about long-term trends, he attributes the weakness to higher interest rates. Read the full piece, but here is a key chart:

Housing starts NDD

The optimist is Calculated Risk. Bill began with an analysis of the housing start data (the sky is not falling) and then a comprehensive update. He does a nice review of the recent spate of weak housing data and the underlying factors. A basic theme is that there is "pent-up demand" in the form of new households. I cannot do justice to the entire article, so you need to read it for yourself. CR writes, "The bottom line is the housing weakness should be temporary. There should be more inventory this year, price increases should slow, and sales volumes increase."

As always, 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 a little good news.

  • The "flash PMI" for the US was very strong. I have not been highlighting these releases, but the pre-market futures seemed to respond. This indicator is going to be like the ADP and the employment report. People will evaluate it based on whether it accurately predicts the official ISM report which comes out a couple of weeks later.
  • Weather gains traction as an explanation for economic weakness. This is important because businesses, consumers, and markets will look past something that is viewed as temporary. Please note that I am not offering a conclusion here. I am reporting the facts. Markets, at least for now, are accepting the weather hypothesis. See a good discussion from Matthew Boesler, including this Goldman analysis of the data:

  • Earnings remain solid. Beware of "throwing out" specific sectors. (Brian Gilmartin).

The Bad

There was plenty of bad news. Except for housing, it was minor.

  • China's flash PMI hit a seven month low. (Reuters).
  • Unemployment has moved to the top problem. (Gallup).

  • Philly Fed was weak. I place little emphasis on this. I doubt that most of the pontificating pundits could write three sentences about this report. It is a survey. We do not know the response rate or the margin of error nor whether responses were low last month. It is a diffusion index. It shows a change from the prior month, not an absolute level of performance. If the level is OK, a read of unchanged would be good. Enough!
  • Japan was weaker than expected on GDP and exports.
  • Housing was bad on all fronts. This is an important theme right now.
    • Existing home sales fell over 5%.
    • Housing starts plummeted and so did building permits (my personal favorite).
    • Homebuilder confidence plunged.

The Ugly

Ukraine. Of course. There is breaking news as I write this. It is an important human story and another chapter in the changing nature of governments around the world. I know that some want to make any conflict into a market story. We can be sympathetic without politicizing our investments. There does seem to be some market reaction to developments, but that should not be our main theme.

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!

Julian Close takes this week's award for an entertaining and persuasive article covering three different sources of misleading information. He takes another shot at the 1929 chart and discusses the "triple top" chart. These simply will not die even when proven wrong. His last effort is a side-splitting analysis of Marc Faber, who always gets plenty of attention. I will not spoil the story. Just read his review of the headlines from Faber's blog and check out the charts.

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 newest recession indicator, showing an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time. For those interested in gold, Georg also sees a possible buy signal next month. Stay tuned!

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

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, you should be reading this update. Doug also has updated the big four indicators important to the NBER in recession dating. Everything except employment is showing a decline – small so far. This is the single best summary of concurrent indicators, so join me in watching it closely.

Matt Busigin has a first-rate analysis of the employment situation, covering many topics with special insight and better use of data. I have followed employment data carefully for many years and I am not easily impressed. This is really good! He covers plenty of news you can use:

  • Household versus payroll surveys – the picture is better than we think
  • The reality of labor force participation
  • We only need job growth of 67K per month to maintain the current unemployment rate
  • How much unemployment is structural
  • Could the Fed respond to a tight labor market faster? Much faster…

The Week Ahead

This is a very big week for data.

The "A List" includes the following:

  • Michigan Sentiment (F). This has extra importance when we are seeking a better read on employment and spending.
  • Consumer confidence (T). Same idea as the Michigan survey.
  • Initial jobless claims (Th). Continues to be the best concurrent information on jobs.
  • New Home Sales (W). Housing remains crucial for the economic recovery.

The "B List" includes:

  • Case-Shiller home prices (T). Seems to lag other price indicators, but widely followed.
  • Durable goods (Th). January data, relevant to those monitoring GDP.
  • Pending home sales (F). All things housing are important.
  • Chicago PMI (F). This is always especially important when the calendar delivers it on a Friday and the National ISM comes the next week --- with employment Friday just ahead.

I am not very interested in the GDP revisions. While this provides a base for future measures, it is "old news" for investors. The conclusion of Yellen's "Humphrey-Hawkins" testimony, to use the old name, is now scheduled for Thursday morning. This is probably an all-time record between the House and Senate versions. While the statement will remain the same, we can expect the Senate members to raise some interesting new questions, especially about weather effects and the possible impact on tapering.

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

Last week Felix made a dramatic switch from neutral to bullish adding trading positions throughout the week. That has worked pretty well. We remain fully invested and there are many sectors that might emerge from the penalty box. It has been a challenging few weeks for traders. While Felix does not anticipate market tops and bottoms, it was a nice mix of risk and reward.

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). I have also highlighted some of the best advice. Here are highlights from this week:

  • Why you should emphasize process rather than outcomes. This is probably the biggest single investor mistake – going for the "hot hand." Barry Ritholtz offers some questions you should ask before evaluating investment returns. He has some interesting football analogies. I strongly agree with the thesis. You need to have a proven process and maintain confidence. Otherwise, you will always sell at the wrong times. It is a foundation of our methods.
  • Why liquidity can be your downfall. Warren Buffett explains why you should usually ignore the market noise about your stocks. I agree. I always have target prices for new buys on my watch list and sales of current holdings if there is an attractive offer. It is infrequent trading, but it is not "buy and hold." Here is how Mr. B puts it:

    "If a moody fellow with a farm bordering my property yelled out a price every day to me at which he would either buy my farm or sell me his -- and those prices varied widely over short periods of time depending on his mental state -- how in the world could I be other than benefited," Mr. Buffett wrote. "If his daily shout-out was ridiculously low, and I had some spare cash, I would buy his farm. If the number he yelled was absurdly high, I could either sell to him or just go on farming."

    That's not how equity holders often react, Mr. Buffett said.

    "Owners of stocks, however, too often let the capricious and irrational behavior of their fellow owners cause them to behave irrationally," he wrote. "Because there is so much chatter about markets, the economy, interest rates, price behavior of stocks, etc., some investors believe it is important to listen to pundits -- and, worse yet, important to consider acting upon their comments."

  • Beware of the profit margin argument. You know. That claim that the market is about to crash because profits are not "normalized." This is an unending, multi-year theme from those who expect a fast market decline. Each year I try to explain why this reasoning is misguided – based on an overly-simplistic bivariate view of the economy. Each year the people in the comments tell me that I am wrong. Here is my most recent effort. The Seeking Alpha version has more comments. Most of those joining in seem to have their minds made up in advance and do not actually read my analysis. I think that profits will "mean revert" but that many other good things will happen at the same time.

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

The market has now demonstrated renewed resilience, but no one knows for sure about corrections. For the average investor this is not the right question. It is more important to focus on fundamentals – the economy, earnings, and the risk of recession. These factors are all encouraging.

I have a special respect for Calculated Risk on housing issues. Bill was accurate on the factors in housing and mortgage markets in the pre-crash era. He has earned a widespread respect among professional economists as he has broadened his commentary and analysis.

I suspect that some of his early followers have moved on as his commentary as become (quite accurately) more bullish. This is especially unpopular right now – both politically and in the popular market media. It is not the path to page views.

Since housing is very important for the economy, I am watching closely. Most casual observers focus on foreclosures and "shadow supply" which ignoring the "shadow demand." These kids cannot live in the basement forever!

Author: "oldprof"
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Date: Thursday, 20 Feb 2014 03:25

The insightful investor understands mean reversion. It is a mystery concept for most – fancy talk.

I will attempt a commonsense explanation with some relevant examples. In conclusion, I will show why this is important.

The Technical Definition

Wolfram MathWorld is a great source on issues like this:

Reversion to the mean, also called regression to the mean, is the statistical phenomenon stating that the greater the deviation of a random variate from its mean, the greater the probability that the next measured variate will deviate less far. In other words, an extreme event is likely to be followed by a less extreme event.

Please note the specific condition of a "random variate."

The Use in Finance

In the financial world, it is commonplace to enhance your arguments about investments with technical jargon. Many readers or viewers get lost along the way. Let me start with a popular application of the concept, the pairs trade.

Suppose that your study of stocks in a specific sector identifies some candidates that you believe to be overvalued and others that are undervalued. This can be an ideal situation for a pairs trade. By going long the cheap stock and selling short the expensive one, you eliminate both the overall effect of the market and also the trends in the specific sector. Your trade focuses on the valuation difference between the selected stocks. You might choose Coke (KO) and Pepsi (PEP) or Ford (F) and GM.

Here is an illustration using GLD (the gold SPDR, representing the actual metal) and GDX (the gold miners).

Notice how deviations in the series closed up during the period from 2009 through 2011. Since then, the trade has not worked very well. If you have been implementing it since the start of 2012 it has been expensive. You might have doubled down, tripled down, or stopped out your position and re-entered. You might have decided to question your original assumption about the relationship between the two. Sometimes the miners hedge their positions by selling gold futures, for example.

The one thing you would not do – at least if you wanted to stay in business – would be to stubbornly stick to the same story without even questioning your thesis.

To summarize, a pairs trade can work in one of three ways:

  1. The overvalued stock can decline
  2. The undervalued stock can appreciate
  3. Some combination of the two

By holding both ends of the trade, you mitigate some risks, although you might still be wrong on the thesis.

And now – the Mystery application

If you follow investment commentary at all, you have seen the most common argument about mean reversion: profit margins. A wide range of pundits insists on the following points:

  1. Profit margins have a powerful mean-reverting tendency
  2. Margins are at unsustainably high levels
  3. Stocks are wildly over-valued as a result. Expect a 30-40% haircut.

This analysis is actually a concealed pairs trade, as is any such argument that involves a ratio. The subject of the mean reversion argument combines two elements: Profits and revenue. Assuming that you agree on the main theme --margins have expanded beyond the normal relationship, the discrepancy could be resolved in any of the classic three ways:

  1. Profits could decline while revenues remain constant
  2. Revenues could increase while profits remain constant
  3. Some combination of the two

The Pundit Error

If a hedge fund employee spotted a potential pairs discrepancy and took only one side of the trade, what do you think would happen?

It would be treated as a rookie mistake – a blunder. He would be admonished or fired if beyond his trading discretion.

Meanwhile, pundits insistently, year-after-year insist that the profit margin issue will be resolved by declining profits. They are betting the ranch on one side of the trade, and picking the wrong one at that. They do not seem to understand that margins are high because revenues are pressured and companies got lean and mean. As the economy and revenues improve, then there will be more competition and profit margins will become more normal.

Please note: This does not require an absolute reduction in earnings and certainly not the doomsday stock forecast. It will be a normal process of economic growth.

Three Ways to Check

This error has been so expensive for investors it may be difficult for them to take an objective, fresh look. Shouldn't we expect more from the pundits? Suppose you stated this profit margin thesis emphatically several years ago, and the results suggest you are wrong. When does the evidence get strong enough for you to reexamine the thesis?

  1. About three years ago I did a favorable review of Vitaliy N. Katsenelson's The Little Book of Sideways Markets. I cited the strong support he had from leading voices like Doug Kass and John Mauldin. I also completely disagreed with the thesis and explained why.

    Regular readers know that I completely disagree with this thesis.  My analysis of data shows that when market participants have an obsessive concern about a recession, the P/E multiples reflect this.  There is plenty of evidence that most people think we are still in a recession, so there is intense skepticism about earnings growth.  Even a modest level of economic growth will restore some confidence.  I already see this in many indicators that I follow each week.  I predict an expansion in the P/E multiple, and each point is about 7-8% of growth.

    My conclusion is that the economy can grow modestly, earnings growth can slow, and yet ---- some confidence can be restored, increasing the multiple.  Unlike other contestants in this discussion, I actually have some data on my side.  Time will tell who is correct.

    This raises a good question.  If I disagree with the major thesis, why do I like the book?

It is pretty easy to see who was right. Profit margins are higher than ever and here is the market chart:

If the profit margin argument sent you to the sidelines, you lost big time.

  1. Assuming everything as equal. Every writer has a few posts that they feel did not get enough attention. Maybe my marketing department should have told me to call this something like "the 1929 chart" instead of Ceteris Paribus. How could I have guessed? Please check it out for an explanation of why the profit margin argument is bogus, my feelings about Jack Reacher, and why you get fooled by bogus charts.
  2. What is left out of daily commentary? Do not allow others to set the agenda! By focusing the market debate on some obscure relationship, investors lose track of actual progress. Take a step back and clear your mind. There has been progress – a lot of it. Better earnings, lower recession odds, less Washington worry, less debt, and reduced headwinds. Don't believe it? Check here, where the Dow was at 10k and many were calling for it to go to 5K.

A Final Thought

I sometimes get stupid comments from trolls or hate-types suggesting that I am hyping stocks. Readers should learn how to differentiate among sources. Fee-based investment advisors profit only when their clients do well. Unlike the "bond kings" we do not have a pre-set agenda. I have programs that emphasize bonds, conservative stocks with covered calls, trading, actively managed long themes, and aggressive investments. My interests are aligned with clients and readers. My market viewpoint changes with the evidence. Those who want to follow the themes get free advice. Those who think I can add value become clients.

I actually have the best program for a sideways market, a concept that will be familiar to regular readers.

I constantly search for the best sources on each theme. You get my unvarnished opinions, and comments are always welcome!

Author: "oldprof"
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Date: Sunday, 16 Feb 2014 04:55

Did last week signal the end of the long-awaited market correction? Less than 10%? What was behind the reversal in stock prices?

The most definitive piece of good news was the end of the debt ceiling debate, although that should not have been a surprise. The Yellen testimony set a record for length, but also lacked surprise.

It was a good week for stocks, but one that left pundits scratching their heads. Is the correction over?

Last Week's Theme Recap

I expected most of last week's attention to be on testimony from new Fed Chair Janet Yellen, starting Tuesday and culminating in front of the Senate Banking Committee on Thursday. On Tuesday this looked like a good call, but the weather intervened. Yellen's testimony was postponed as Congress left early for the February recess, which ends on the 24th. Yellen will repeat her statement, but the Senate questioning could be quite different.

While I have frequently discussed weather effects, even giving my "ugly" award to the polar vortex in a recent post, it played a larger role than I expected last week.

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.

This Week's Theme

The market rebound in the face of weak economic data challenges pundits of all stripes. The improvement in earnings now seems like history, with renewed focus on yet another "soft patch" in economic data. Some will attribute this to the weather, but that explanation (excuse?) can only persist for another month.

Is the correction over? Here are five basic positions:

  1. Seasonality. Cash inflows favor stocks early in the year. Even the "sell in May (or March or April) gang is throwing in the towel on timing.
  2. Technical analysis. Charles Kirk's excellent weekly chart show demonstrates the dramatic shift from bearish to bullish setups for traders. This site requires a modest annual fee which anyone would quickly recover from better trading and investing. Charles adjusts with the data. (Our Felix model frequently agrees with Charles. Good for Felix!)
  3. Short covering. Too much of the hot money continues to play for a correction. They were caught off base last week.
  4. The Fed. Back to the favorite explanation. Something from Yellen shows fresh support for stocks.
  5. Housing. Some see a real turnaround. Joining Calculated Risk (see here) in the bullish camp is Applied Global Macro Research, with an out-of-consensus forecast of 4% GDP growth. They see pent-up demand in housing. Like Calculated Risk, they were also accurate on the downside. (See the Barron's cover story).

As always, 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

Much of the recent news was pretty good.

  • Michigan sentiment was solid. While not a big move, it contrasts with plenty of negative economic data. Doug Short's combination of the history of the series with economic growth and recessions is my favorite sentiment chart:

  • Earnings have beaten expectations. FactSet summarizes as follows:

    Earnings Scorecard: Of the 399 companies that have reported earnings to date for Q4 2013, 71% have reported earnings above the mean estimate and 66% have reported sales above the mean estimate.

Earnings guru Brian Gilmartin analyzes the forward earnings implications for 2014. Is a 20% gain possible?

The market reaction has often been critical, seeking out any flaw in forward guidance, underlying metrics, or the elusive "earnings quality." Despite this skepticism, stocks have rallied on earnings days, as shown in this great chart from Bespoke:

  • No imminent debt ceiling or budget issue. This development seemed to take the market by surprise on Tuesday. I trust that regular readers fully expected the outcome at some point. As I have often noted, the GOP has decided that the debt limit/government shutdown is not a winning political strategy. It is better to focus on ObamaCare, at least going into the mid-term elections. Regardless of what you think about the policies involved, this is a market-friendly move. We will not face a debt ceiling or budget crisis for the next year. This might have been the most important news of the week. Only last week I was bemoaning the lack of progress!
  • Eurozone GDP increased more than expected – 0.3%. This is reflected in economic news and interest rates from various specific countries – a pattern of improvement.
  • Yellen reassured. Tim Duy has an excellent account, covering all of the bases. His charts and analysis show the specific factors involved in future decisions, but also the flexible nature of the interpretation. Helpful charts as well.
  • The market did not crash 40%, as predicted by a prominent market-timer. I noted last week that many individual investors may have been scared out of the market by the attendant publicity. To my surprise, an experienced trader opined that many hedgies were caught leaning the wrong way because of this. That might explain the apparent short-covering, but not why anyone would pay 2 and 20 to people who would fall for silly chart manipulation.

The Bad

There was plenty of bad news.

  • Consumers are spending beyond their means. Can this continue? Steven Hansen raises the concern that this cannot continue. (Scott Grannis thinks that it just shows confidence in the economy and improved balance sheets).

  • Industrial production declined 0.3%. This was a big surprise versus expectations of a 0.3% gain. Steven Hansen analyzes the unadjusted data and suggests that the results are even worse. The Capital Spectator muses about weather.
  • Weather costs may have been as much as $50 B and 76,000 jobs. (CNBC).
  • Retail sales fell 0.4% confirming reports from some specific stores. Calculated Risk has analysis and charts, including this one:

The Ugly

Facebook fraud. I guess you can no longer buy "likes" from a click farm, but you can do the same thing officially through Facebook. Thanks to Barry Ritholtz for highlighting the issue with a fascinating video. With the growing importance of social media, we need to beware of false metrics.

I check in on Facebook a couple of times a week to keep up with friends. For me it is personal, not business. I also ruthlessly defriend or ignore anyone who uses this as a political platform. (My little sister has returned from exile). I want to have fun. I also have no position in the stock.

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!

This week's award goes to those who stepped up with a timely debunking of the infamous 1929 chart – Ryan Detrick of Schaeffer's and Bespoke Investment Group.

First – a little background.

Despite our warning last week, this fear was getting mainstream traction. Mark Hulbert (when was his last bullish column?) wrote, "The picture isn't pretty. And it's not as easy as you might think to wriggle out from underneath the bearish significance of this chart." This week Barron's quotes Raymond James' Jeffrey Saut. "I have been in this business for over 43 years, yet I do not ever recall getting as slammed with the same e-mail as many times as I have about the attendant 1929 comparison chart." In the unlikely event that you have not seen it, here it is:

Tumblr_inline_n0ubzvxaUu1sr2715

Ryan Detrick did not have any trouble with Hulbert's wriggling. He simply noted the difference in the scales, adjusting for an apples-to-apples comparison:

Tumblr_inline_n0uc4e8rea1sr2715

See the full article for a comparison of the current market streak with those of the past.

The Bespoke team did a similar analysis for subscribers – the same day as the Hulbert column. They have shared the link to their great charts.

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 newest indicator, showing an increase in the "weeks to recession" from 26 to 27. This does not mean that there will be a recession in 27 weeks. Instead, it shows that the chance is "statistically remote" that a recession would start during that time.

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

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, you should be reading this update. Doug also has updated the big four indicators important to the NBER in recession dating. Everything except employment is showing a decline – small so far.

The Week Ahead

This is some important data in a shortened week.

The "A List" includes the following:

  • Housing starts and building permits (T). Important for continued economic recovery. What about weather effects?
  • Initial jobless claims (Th). This report covers the same week as the monthly payroll report for February.
  • FOMC minutes (W). You might think we know all about Bernanke's last meeting as chair, but Fed watchers will be parsing the minutes for any hint of new information.
  • Existing home sales (F). While less directly related to economic expansion, some see this as a better housing indicator.

The "B List" includes:

  • Leading indicators (Th). Remains a popular indicator for many.
  • PPI (W). Of secondary interest as long as increases are tame.
  • CPI (Th). See PPI.

I am not very interested in the regional Fed reports. We'll get a normal ration of FedSpeak, and the last of the major 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 made a dramatic switch from neutral to bullish. We added trading positions throughout the week, beginning on Monday and Tuesday. We were fully invested on Thursday. I had expected one of the inverse ETFs to exit the penalty box, leading to a short position, but it did not happen. As long as there are at least three attractive sectors, Felix will look for the "bull market somewhere." It now appears that even stronger candidates that might emerge from the penalty box.

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). I have also highlighted some of the best advice. Here are highlights from this week:

Don't get emotional. Josh Brown has his own valuable take on The Chart that Wouldn't Die. He explains that it does not matter how much the chart is debunked. The sellers of fear are playing upon your emotions about risk and reward. Josh writes as follows:

The reason why this bothers me is twofold – first, it frightens investors into making poor decisions – big decisions that will have a major impact on their mental health and financial condition well into the future. Second, the more we see this kind of pornography, the more likely it is to have an impact on crowd psychology and become a self-fulfilling prophecy. It's like putting a disturbed, isolated teenager in front of violent first-person shooter video games all day. If we know that most Americans are scared to invest in their own future, what's the reason to fuel that fear even further? Sadism? Or just plain exploitative greed?

Don't get carried away by politics. Ideology is Killing Your Investment Returns, says Barry Ritholtz. He provides compelling examples covering a range of issues, ideologies, and political parties. There is a specific list of traps and this conclusion:

Once you become aware of how your biases affect your portfolios, you have a choice: You can recognize the impact it has on your thought process and make adjustments, or you can ignore it, and suffer the consequences.

Ideology remains an awfully expensive indulgence. If you feel compelled to waste vast amounts of money, consider instead collectible cars, vintage watches and vacation properties. Your heirs will thank you.

Don't think you can time the market. Cullen Roche analyzes the idea that you can wait for the big correction. He has many great points, but here is a key quote:

The "fat pitch" myth misses the way most of us get rich in markets.  Most people who make sizeable gains in the markets do not swing for the fences or try to hit home runs.  Sure, the home run hitters are always the people who garner the most attention.  But they're also a fairly rare occurrence and the fact that someone hit a 800 foot home run in 2008 doesn't mean that person was necessarily talented or doing something that can be replicated.  The thing is, most of us get wealthy in the markets by hitting lots of singles, doubles and just getting on base a lot.  The best part about the market is that you don't have to swing a lot.  But that doesn't mean you have to wait for fat pitches to try to hit out of the park.

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

The market has now demonstrated renewed resilience, but no one knows for sure about corrections. For the average investor this is not the right question. It is more important to focus on fundamentals – the economy, earnings, and the risk of recession. These factors are all encouraging.

Those who have avoided the traps and misleading information have done well. Just take what the market is giving. Genius is not required! Even conservative investors should be able to beat inflation and grow their portfolios.

Fund flow data show that those who were waiting for a correction did not, on balance, do any buying. It is really tough for most to swing at the right times. The fat pitches look like knuckleballs!

Author: "oldprof"
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Date: Sunday, 09 Feb 2014 05:52

After a wild week for U.S. equities and some weak economic data, the market will be curious about how the Fed sees the evidence.

What should we expect from the new Fed Chair?

You might think that the confirmation process has already answered this question. In fact, it is not unusual for office holders to see things differently once actually in the job.

The week ahead also features plenty of other FedSpeak, but less activity on the data front. The Yellen testimony should dominate, starting with the pre-market release of her statement on Tuesday and lasting through the Senate question period on Thursday.

Last Week's Theme Recap

I expected a week-long focus on whether the US economy was stalling out. That was a very good guess. Starting with the weak ISM data on Monday, we had a roller coaster market experience. There was fresh and important data every day. Doug Short captures the story in one of his typically enlightening charts:

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.

This Week's Theme

We have a new Fed Chair, making her first appearance before Congress, starting on Tuesday before the House Financial Services Committee and continuing before the Senate Banking Committee on Thursday. (This legislatively-required appearance is semi-annual, with the Senate getting first dibs in the summer). With recent data presenting a mixed economic picture, everyone will be watching for a hint of a policy shift. This will also be the first chance for Congressional critics to take on a new target.

We can classify the various expectations as follows:

  • Data imply less tapering. Kathy Lien has a very nice explanation of the "trader perspective." She asks whether weaker data will force Yellen to alter the pace of tapering or change forward guidance.

    The main takeaway from Friday's labor market report is that the U.S. economy continues to recover, albeit at a slower than anticipated pace. In some ways, this is good news because it means that the Federal Reserve won't taper asset purchases too quickly. Instead, they may have to consider ways to amend and strengthen forward guidance as the unemployment rate approaches their 6.5% threshold.

  • The Fed is dominated by Econ PhD's. True—and a big change. This Harvard Business Review article by Justin Fox explains why and how the change occurred. Hint: A switch from regulation to monetary policy.

As always, 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

Some of the recent news was pretty good.

  • The earnings beat rate has been very strong. The market reaction has been critical, seeking out any flaw in forward guidance, underlying metrics, or the elusive "earnings quality." Better to focus on the actual data. Here is Bespoke's fine summary:

  • Earnings growth is close to 10%, year-over-year, just as Brian Gilmartin predicted before the reports started. The earnings story is not just one of beating lowered expectations. Most of the popular reports focus on the expectations dynamic, missing the genuine growth.
  • Home prices are up 11% year-over year. December data from CoreLogic (Calculated Risk).
  • Initial jobless claims moved lower, back to the 330K range.
  • Bullish sentiment declined yet again – a contrarian indicator. I have been showing the weekly changes in the AAII indicator. Ryan Detrick shows several sources. Here is one dramatic example:

  • ISM services strengthened – from 53 to 54. Steven Hansen looks at the long-term picture as well as the recent month. He identifies underlying factors that correlate well with economic growth, and notes that they continue to signal expansion.

The Bad

There was plenty of bad news.

  • No progress on the debt limit. While I still expect a reasonable and timely compromise, there is no progress so far. Treasury Secretary Lew has now set a deadline of February 27th. (The Hill).
  • Rail traffic weakened. GEI has the full story, with a nice table of trend changes.
  • High frequency indicators, monitored carefully by New Deal Democrat, are reflecting what he calls a "big chill." Check out the full story to see the weekly update, as well as thoughtful context.
  • The ISM manufacturing index showed a big decline. Ed Yardeni looks at the components, the miss, and questions those blaming it on the weather.

  • Car sales were generally worse than expected – especially Ford and GM.
  • The Employment Situation Report was disappointing in terms of payroll jobs growth. Since that is the best long-term measure, I am scoring it as bad news. There were some mixed aspects to the report, including more jobs in the household survey and a lower unemployment rate. Those objecting to the seasonal adjustment method noted that if last year's method had been used, the job gain would have comfortably beaten expectations. (See Michael Strain at AEI). There were also complications from the annual "benchmark revisions" explained nicely by Felix Salmon. The positive market reaction was mostly ascribed to improved chances for more favorable Fed policy. Scott Grannis sees the report as showing "nothing new." Here is his chart of monthly changes in private payrolls:

The Ugly

Politics and the Olympics. There are issues that divide countries – as always. The Olympics provide not only a platform for partisan cheering, but an educational opportunity. Athletes make friends and viewers learn a bit about other cultures. Like you I have some strong viewpoints on the issues, but this is not the right forum for that debate. (See The Hill for more on the reaction and also the provocation).

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: Features a new indicator, showing that a recession is not part of the near-term outlook.

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

Doug Short: An update of the regular ECRI analysis with a good history and commentary. See the detailed analysis and charts.

The Week Ahead

This is a relatively quiet week for news and data.

The "A List" includes the following:

  • Retail sales (Th). Plenty of interest after reports from stores and weather questions.
  • Initial jobless claims (Th). Best fresh data on employment, more important than ever after last month's employment report.
  • Michigan sentiment (F). February data. Good concurrent insight on employment and consumption. Some leading qualities.

The "B List" includes:

  • Industrial production (F). January data, relevant for the NBER economic outlook.
  • Inventories – wholesale (T). December data. Promoted in significance because so much of recent GDP gains are linked to inventory builds. By design or by accident?
  • Inventories – business (Th). More December data. See above.

The economic data will definitely take a lesser role this week. We still have plenty of earnings news. Yellen will take center stage with a long list of other Fed types throughout the week. Expect these to make some news, especially when related to the pace of tapering, or the powers and leadership of the new Chair.

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 in neutral mode, but close to a bearish forecast. We further reduced trading positions during the week, ending with 100% cash. I have been expecting one of the inverse ETFs to exit the penalty box, leading to a short position, but not so far. We have often seen this in the past. Felix shows some high ratings on the inverse funds, but they never get out of the penalty box. Making an accurate correction forecast is much more difficult than many claim.

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. This is the "actionable investment advice" 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). I have also highlighted some of the best advice.

Josh Brown highlights the mistake of chasing performance, using the example of the flight from emerging markets in a fifteen-week period in 2002. These markets then went on a four-year run, beating the overall world market. Check out the full story and charts.

Bill McBride explains his five reasons to expect the economy to improve.

In sharp contrast, whenever there is a decline in stocks you can expect to see plenty of doomsday forecasts.

  • Noted market timer Tom DeMark was featured by many for his forecast of a 40% market decline within the next few days. His analysis was that the current market chart was like that of 1929.
  • Equity fund outflows set a record last week, with $28.3 billion leaving stocks and half of that amount going into bonds.

We cannot blame DeMark for the entire change, but he does symbolize the dysfunctional state of financial information. It is not very newsworthy to focus on the boring continuation of improving fundamentals. Meanwhile it is open season if you can compare a current chart to some past disaster.

Those who prefer being scared, confirming their biases, or being entertained by conspiracy theories are paying a high price.

I am still shopping for stocks. I have some cash in our long stock program, and I was buying early last week. The mission that I described in my regular annual preview interview with Seeking Alpha is still valid, with the themes very much in play. You need to start with risk control, as I emphasize.

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

For the average investor it is important to focus on fundamentals – the economy, earnings, and the risk of recession. These factors are all encouraging.

Despite this, short-term factors are likely to contribute to a choppy market.

  • How much of the recent economic activity should be attributed to weather effects? I do not like to make excuses, throwing out data that do not fit some pre-determined conclusion. Every analyst I respect agrees. Meanwhile, we must recognize when there is some valid explanation for an unusual outcome. It can be difficult to make this distinction. Should we be surprised that much of the country has snow and cold in January? Despite my skepticism, I see signs that this is pretty unusual. Eddy Elfenbein's take is pretty accurate:

    I suspect, though I'm not certain, that the recent weakness was due to lousy weather around the country. Normally, I'm skeptical of that kind of thing, but we saw it confirmed in other reports like retail sales and car sales. Ford, for example, had a poor month in January, and we know that business is going well for them. The market usually doesn't rise that much on a good jobless-claims report. So why was Thursday an exception? My guess is that it eased the fears of a broader macro downturn.

  • The "challenges to the new Fed Chair theme" is very misleading. The piece I cited is better than prior entries, but it is still deeply flawed. Putting aside the error in the citation (not "the UBS economists" but a single non-economist who specializes in derivatives) we have a handful of case studies in very different circumstances. Putting them all in a single chart is less helpful than a comparative case study. That would require a real article, with actual research on each case, something we do not see much anymore. (See here for more).
  • The Fed will not be swayed by weakness in emerging markets. This summary from Josh Brown reflects my thinking, familiar to regular readers.

I do not expect a reduction in the pace of tapering. Since I do not ascribe much of the recent market performance to QE, I am not worried about ending the program. Eventually this will prove out, but it is still central to the ongoing market debate. Too many observers persist in explaining everything in terms of Fed policy.

Author: "oldprof"
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Date: Sunday, 02 Feb 2014 05:42

After another bad week in U.S. equities and a worse week in emerging markets, some are starting to question the strength of the global economy.

Can the slow and prolonged recovery be derailed by some ill-chosen policies in a few small countries? Are we hostage to some bad hedge fund trading decisions, the way we were in 1998?

The week ahead features plenty of important economic data and earnings results. I expect this real news to displace the emerging market meme.

Last Week Recap

Last week I suggested that we would have another week of pundits on parade. Everyone would be interpreting each 1% move in the market as evidence that their analysis was correct. This was a pretty accurate summary of the news flow from financial media, especially the characterization of "triple-digit" moves in the DJIA as a meltdown. These sources have no shame when it comes to sensationalizing the news.

I also accurately suggested that the Fed would ignore emerging markets and that weather would be an important topic. 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. There are some Mondays when I think the CNBC producers have been reading my postJ

This Week's Theme

Economic data have turned a bit softer over the last month. What does this imply?

  • For some, it takes only a few reports to signal the worst. The yield curve has flattened, with the 10-year note well off of the recent highs. Even if this is "flight to quality" buying, it suggests a deflationary threat. When the Fed announced the continuation of tapering at the prior pace, some expected the long end of the curve to increase in yield. Remember the recent questions about who would buy bonds if the Fed cut back? Instead, we are seeing lower long-term rates. Does this mean a weaker economic forecast? Is the Fed wrong? BondDeskGroup has a good analysis of the factors as well as this chart:

  • For others, the recent GDP report shows some important trends. Prof. James Hamilton looks at the underlying components, noting that allowing for the government "drag" shows that the U.S. economy is gaining momentum.

Gdp_components_jan_14

This week we will see plenty of real data and more corporate earnings reports. It will be a big week for data, helping us to evaluate the threat to the economic recovery.

As always, 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

Some of the recent news was good.

  • Bullish sentiment declined yet again – a contrarian indicator. According to Bespoke Investment Group this is the fourth consecutive decline in bullish sentiment, with bears now leading bulls for the first time since August.

  • The Keystone pipeline cleared a key enrionmental hurdle. This would help the economy in many ways, so the environmental tradeoff is the key. (The Hill).
  • Rail traffic remains strong. Those who are skeptical about government reports should pay special attention. (Cullen Roche).

  • Truck tonnage, too. (Scott Grannis).
  • China's official PMI came in as expected, at 50.5. This report came Friday night, after the US markets closed. After the "flash PMI" that showed slight contraction, some were worried about a surprise in this measure. It is obviously still a near-neutral growth reading, but the whisper seemed to be worse. (See Lucy Hornby's FT.com report from Beijing).
  • Earnings season is going well, which must be a surprise to the casual observer. Earnings expert Brian Gilmartin is sticking with his prediction of a YoY increase of 10% in Q4 earnings. He also sees a similar increase for calendar 2014, but he is more cautious about the market reaction. Bespoke charts the progress in the "beat rate" for this earnings season.

Beat Rate Update

  • The money supply is growing – needed for the economy – although other frequent indicators are mixed. (New Deal Democrat).

The Bad

There was plenty of bad news.

  • GOP split on immigration reform making action during this year unlikely. (The Hill).
  • The January Barometer. As goes January, so goes the year, says the theory. Ryan Detrick at Schaeffer's takes a deeper look, so you can decide for yourself if this is worth using.

  • Economic confidence declined. Gallup links it to the stock market, but I doubt that. Most people do not watch stocks that closely.

Jr4-vjhu2egazcxk7cv_4w

  • Real Personal Income is contracting even though spending is higher. Steven Hansen has an in-depth analysis, considering the NSA data as well. Doug Short has updated his "Big Four" chart to reflect this weak report.
  • Pending home sales showed a surprising, large decline of 8.7%. Calculated Risk explores the reasons – not just the weather excuse, but inventory and demand as well. Bill also notes that new construction is more important to the economy.
  • Durable Goods orders declined sharply, down a surprising 4.3% and now up only slightly on a YoY basis. Steven Hansen looks at the NSA numbers as well. Doug Short illustrates many adjustments to this complex series, illustrating the effects of population, inflation, and the most volatile sectors. Here is a good example of the helpful charts:

The Ugly

Emerging markets. Currencies are failing and their stocks are declining. Izabella Kaminska at FTAlphaville asks whether the outflows have "only just begun?" The post includes some great analysis and charts. She notes that the Fed does not seem to be considering this in policy decisions. This will be no surprise to my regular readers.

Scott Grannis explains why this is not about Fed tapering. Good charts.

Noteworthy

Barry Ritholtz and Peter Schiff both accepted the challenge to appear on The Daily Show to discuss the minimum wage. Putting aside your personal opinion about the issue, you will enjoy watching the segment. Let us just say there is quite a disparity in the impression made, although the participants did not directly confront each other.

For comparison, take a look at last summer's "debate" between Schiff and economist Scott Sumner on Kudlow's show.

Sumner is a highly-regarded academic, whose work has clearly influenced recent Fed policy, but he does not have the same experience in this type of media setting. He did quite well, but had academic explanations rather than sound bites.

This is great fun to watch, and also instructive about what we can learn from different media approaches. How do you get your news?

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: Takes a look at potential stock returns through 2020, using the 5-year Shiller CAPE. He has also updated his market timing method, which still calls for a leveraged investment in stocks. This week he reveals a new indicator, showing that a recession is not part of the near-term outlook.

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

Doug Short: An update of the regular ECRI analysis with a good history and commentary – well worth reading.

Econbrowser's recession index has declined to a 3.3% probability.

I made a friendly suggestion to the ECRI: Time to ask for a fresh shot clock! They are not alone in needing to reconsider failing models.

The Week Ahead

This is another big week for news and data.

The "A List" includes the following:

  • Employment report (F). Despite the volatility and issues of interpretation, this remains the most important release.
  • ISM index (M). Good contemporaneous data on economic strength and employment, with some leading quality.
  • Initial jobless claims (Th). Best fresh data on employment, more important than ever after last month's employment report. (Not part of the survey for the Friday report).

The "B List" includes:

  • ADP private employment (W). Often alters expectations about the Friday data. Good independent read.
  • ISM services (W). A shorter series than manufacturing, but still quite valuable.
  • Trade balance (Th). Relevant for GDP.
  • Auto Sales (M). Good evidence from a non-government source.
  • Construction spending (M). December data, but still interesting.
  • Factory orders (T). Also December data.

It is still the heart of earnings season, with many important reports. With the Fed decision made, the participants are free to give speeches. While the decision was unanimous, we can expect some additional color from several presentations this week.

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 switched from bullish to neutral – close to a bearish forecast. We reduced trading positions during the week, closing out a brief but profitable trade in biotech (IBB). Our one remaining position is a European ETF. While we have no short positions (via the inverse ETFs) that could change during the coming week. The ratings have shifted to slightly negative, but many sectors are still in the penalty box.

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. This is the "actionable investment advice" summarized here.

This is an important time for long-term investors. They all know (in theory) that market corrections of 15% or so occur regularly without any special provocation. Recent years have been the exception. Whenever there is a decline in stocks you can expect to see plenty of doomsday forecasts.

This WTWA series is designed to maintain focus on market fundamentals. The featured advice this week comes from some great sources:

  • Rick Ferri explains that bond/stock correlations are often not the best guide for portfolio rebalancing. In a thoughtful post, he points to a Treasury position as a way of reducing risk, not increasing return. While I prefer different choices for the "safe" part of the portfolio, I agree that everyone should start with risk control! Here is a key chart showing the dramatic change in the relationship between stocks and bonds:

Correlation-Fig2

  • Eddy Elfenbein explains emerging markets. There is a real skill in taking a complex subject and explaining the crucial aspects in a clear fashion. Eddy is a master, and combines wit with wisdom. Every investor should take a minute to read the full article, but here is a taste:

    The situation in Argentina is especially screwed up—although when I use the phrase "screwed up" in conjunction with our friends on the Rio Plata, it's like saying there's "trouble" in the Middle East. The president of Argentina didn't make any public appearances for six weeks. Can you imagine if President Obama had done the same?

    President Kirchner promised not to devalue the currency, but reality intervened. Of course this was after the government spent a pile of cash trying to defend the indefensible peso. In the last three years, Argentina's currency reserves have been cut in half. No one really knows what the inflation rate or dollar-peso exchange rate truly is.

    There are a lot of people in Argentina, in and out of government, whose job it is to see how well the economy is doing. They track all sorts of complicated econ data, but I have a simple rule I use: How loudly are the politicians yapping about the Falklands? If they're loud, you can be sure that means the economy is a wreck.

  • Schwab's Liz Ann Sonders calls the equity market the "best in our lifetime."

    "There is a slightly elevated risk of a 10% correction this year, but I don't think the secular bull market is over," she said. "I have some short-term concerns, but I personally think the bull market we're in now will be the best is our lifetime."

    Some of the driving forces she identified include the fact that U.S. businesses "are sitting on a huge hoard of cash, which is at a level not seen since World War II," she said. "We know the capital is there, but we haven't had the animal spirits to put it back to work yet. But this is the year we'll probably see increase in [capital expenditure] spending."

  • Josh Brown explains, in his characteristic colorful fashion, "Vol Happens" and the 2014 playbook is different.

I am still shopping for stocks. I have some cash in our long stock program, with a mission that I described in my regular annual preview interview with Seeking Alpha. The interview combines strategy, perspective, and some specific themes. As I often do, I start by emphasizing risk control. I see that as crucial in dealing with the temptations to engage in poor market timing. Several of the themes I mentioned are near the buy points.

While I am not trying to time a correction, I do have more than a normal cash level, raised through normal trimming. I am actively shopping in the sectors I have highlighted.

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

For the average investor it is important to focus on fundamentals – the economy, earnings, and the risk of recession. These factors are all encouraging.

There are plenty of distractions. Turn on "ignore" mode. I have to monitor this stuff, but you do not.

  • Politics is already becoming a big factor. As I predicted last week, there was little in the State of the Union speech that could help investors. There certainly was plenty of noise about it. You should not care about this, nor the problems of specific candidates.
  • Keep the anecdotes from the old-timers in perspective. (I know, I know. I qualify for the old-timer club!) I always hate it when analysis proceeds from a single example – usually without any real perspective. This week it was reminiscing about the Thai baht, the Asian Contagion, and the market reaction over a year later. There are many steps between the currency problems in a small country or two and a major economic impact either for the US or the global economy. It is so easy to write a post or do a video showing a chart and a few facile comparisons.

None of this has any proven, long-term investment value. Instead, why don't we focus on the real information? We'll get plenty in the week ahead.

Author: "oldprof"
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Date: Friday, 31 Jan 2014 03:32

What do you do when your trading system goes wrong?

Two possibilities:

  1. Has the world changed? Do you still have an edge?
  2. Or is this a "blip" that is within the expected error tolerance?

If you are an experienced researcher, you can employ various statistical tests, determining whether or not the actual results are plausible. Most actual traders have much less patience!

A Super Bowl Example

Regular readers know that I am a big sports fan and I also love the statistical analysis of sporting events. Looking at these examples is good for investors since it takes them away from pre-conceived market opinions and into a different universe. So let us discuss the Super Bowl.

John Dewan's Stat of the Week provides a consistently strong stream about baseball, my favorite sport. I have enjoyed the regular posts, helping to illustrate the strengths and weaknesses of both teams and players. If you share my love of baseball, you should subscribe to this weekly update.

But this is about football. John has a Super Bowl system that worked 90% of the time! Until the last seven years, where it went 2-5. He is reporting the forecast, but retiring the system – and not using it for his official pick.

The key point? He does not know exactly what went wrong, but a 90% system does not go 2-5. It was time to move on.

Implications for Investing

Today's GDP report underscores the error of those who have predicted recessions and economic collapse. The investment world is replete with broken models – forecasts that have been sadly wrong. I am going to split these sources into two broad camps, based upon the financial rewards of those providing the information. If the investor had to pick one thing to follow, that would be a good choice.

Profit from Product Sales

This group includes those who do not focus on results. They sell conspiracy theories, seminars and conferences to confirm your biases, bonds, research that is mostly for bond clients, and page views.

Profit from Results

I want to focus on this group. Their success depends upon helping readers and clients.

For over a year I have had a post prepared with the title "RIP ECRI Recession Forecast." I have been waiting for the intelligent and engaging people at the ECRI to re-evaluate their methods. To everyone except them, it is obvious that something went wrong with their model. Those of us who follow their work closely can even make an educated guess, having reverse-engineered the components. (They use too many correlated market variables and not enough fundamentals. They wanted to be fast, avoiding revisions. More variables does not equal better. When commodity traders embraced the inflation thesis after the start of QE, it drove those prices really high in 2011. When the inflation did not develop, the commodity prices collapsed. To the ECRI model this looked like death. That was a big mistake. They needed a good consultant who understood the fundamentals). Whether you agree with my guess or not, their model is obviously broken. They should choose to say, "Something went wrong, we tweaked, time to move on…" and we would all have accepted that. Instead there is a stubborn adherence to a mistake.

I have also been stalling on some posts related to the famous fund manager whose methods always seem to start with the conclusion and then identify the "independent" variables. He is personally engaging and generous. He would seem to be aligned with clients, since his performances is on the line. (Or maybe I am wrong. He is so good at marketing. Maybe people are happy to invest with a fund that reflects their market viewpoint, regardless of performance). The problem is his methodology. He is overdue to bring in an outside consultant who will critique his work instead of relying on employees who provide research to order for the company line. I was offered a job like that once, and I turned it down.

Investment Conclusion

Any experienced model developer has both successes and failures. Sometimes the reasons are technical. On other occasions the market catches up with your approach. The serious modeler goes to work, analyzing and fixing if necessary.

If you have been paying attention, you have noticed a world littered with broken methods – omens, seasonal forecasts, cycles, and predictions for "mean reversion." Those with broken models should have had a New Year's resolution to re-examine and fix. If someone is no longer working hard to improve his methods, maybe we should not be paying any attention.

 

Author: "oldprof"
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Date: Monday, 27 Jan 2014 05:05

After a bad week in U.S. equities and a really bad week in emerging markets, is there a relevant message? If so, does it matter for day traders, swing traders, investors, or all of the above?

The week ahead features a real free-for-all with plenty of data, Fed news, and earnings results. After weeks of a data drought, there is finally something to savor.

Last Week Recap

Last week I suggested that we would have a parade of pundits debating the idea of a market top. Earnings would take second fiddle. That was pretty accurate, especially in the Thursday and Friday selling that were described as "ugly" and "carnage" on financial TV.

This Week's Theme

The market action has taken center stage, with everyone trying to infer the message from the 2.6% decline in the S&P 500. Here are the many contenders:

  • Proof that the entire 2013 rally was "built on sand" and that the Fed folly will soon be exposed. The Fed will be forced to reverse the planned tapering, which itself will be a recognition of the futility of all central bank policy.
  • Proof that market valuation is in bubble territory.
  • A recollection that the current issues are similar to some past crisis in Asia or Mexico or somewhere. Those past examples created a big market reaction and had memorable mnemonic names.
  • Evidence that the long-expected market correction has begun.
  • A "healthy" and modest correction.
  • A meaningless blip, especially in the context of prior gains.

You can find backers for any and all of these horses. The biggest lesson seems to be how every pundit sweeps aside what has been happening for many months, and seizes on the "market message" from a few days as confirmation for his own preferred theory.

As always, 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

Some of the recent news was good.

  • Bullish sentiment declined again – a contrarian indicator. Here is the chart from Bespoke:

  • The trucking index is higher – up in December after a surge in November. (See Calculated Risk).
  • World industrial production is strong – a new high for the cycle. (See Ed Yardeni).

  • Earnings season is going well – despite the spin and heavy emphasis on a few big names. The chart is from Bespoke. Also see Brian Gilmartin's must-read update on Q4 results and changes in forecasts.

 

 

The Bad

There was a little bad news.

  • More Americans feel worse off financially than a year ago. (Via Gallup).

  • Retail store closures are surging, with possible secondary effects. (Business Insider).
  • China's flash PMI signals contraction. This is the HSBC/Markit version, coming out before the "official" data and with a slightly smaller completed sample. The reading was 49.6 compared to last month's 50.5. Anything below 50 signals contraction. I am scoring this as negative since Art Cashin said it accounted for 70% of Friday's market decline. Meanwhile, the level-headed John Lounsbury notes that the flash PMI has been below 50 in half of the months over the last three years. John observes that the world did not end on these occasions.
  • S&P 500 challenges technical levels including breaking the 50-day moving average. Eddy Elfenbein explains:

 

The Ugly

Weather. Another polar vortex threatens travel, employment, retail sales, and even the Super Bowl. I am expecting 17 below tomorrow morning here in the Chicago burbs, and we're not talking wind chill!

 

Noteworthy

Pressure from the wings --

Arizona GOP censures McCain for 'liberal' record (because the 2008 GOP Presidential nominee has supported too many liberal causes like immigration reform)

Black lawmakers to go after Obama (because of insufficient diversity in judicial appointments)

In general, investors do best when the path is open for compromise.

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 the Economy

Georg Vrba: Takes a look at potential stock returns through 2020, using the 5-year Shiller CAPE. He has also updated his market timing method, which still calls for a leveraged investment in stocks. Most recently, he examines whether there is a best time of day to trade.

RecessionAlert: Sees improvement in leading indicators for US growth, while highlighting danger areas worth monitoring. See the article for detailed charts on each indicator.

Doug Short: An update of the regular ECRI analysis with a good history and commentary – well worth reading. Here is the key chart:

See also the Cleveland version of a financial stress indicator.

The Week Ahead

This is a big week for news and data.

The "A List" includes the following:

  • FOMC rate decision (W). For those who continue to believe that it is "all about the Fed" and media types needing a story, this will signal whether the pace of tapering will change.
  • New home sales (M). Continuing crucial role in economic growth.
  • Michigan sentiment (F). Good concurrent read on employment and spending.
  • Consumer confidence (T). See Michigan above. Usually correlated with that survey, but perhaps not as good.
  • Initial jobless claims (Th). Best fresh data on employment, more important than ever after last month's employment report.
  • Personal income and spending (F). Key component for measuring economic improvement.
  • Durable goods (T). Another of the major components of GDP.

The "B List" includes:

  • Case-Shiller home prices (T). Just twenty cities and a bit lagging, but widely followed.
  • GDP for Q4 (Th). The early reading will be revised twice in the near term and eventually even more. By now it is more like history, but perhaps the most important single summary measure.
  • Pending home sales (Th). All housing data matters, but this less so than new construction.
  • Chicago PMI (F). Prominent once again as a read on the national ISM number, coming out next week.

The State of the Union Address on Tuesday will be newsworthy, but without a clear market angle. It is still the heart of earnings season, with many important 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 continues to be slightly bullish. Even over the last few "neutral" weeks we have been fully invested in the top three sectors. Felix's ratings have been in a fairly narrow range for several months. These are three-week forecasts, so the jury is still out on the marginal bullish switch from last week. The ratings remain slightly positive, but many sectors are still in the penalty box.

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. This is the "actionable investment advice" summarized here.

This is an important time for long-term investors. They all know (in theory) that market corrections of 15% or so occur regularly without any special provocation. Recent years have been the exception. Whenever there is a decline in stocks you can expect to see plenty of doomsday forecasts.

This WTWA series is designed to maintain focus on market fundamentals. The best advice comes from some favorite sources:

  • Don't think you can time the market, with big "poker-style" moves of all-in or all-out. Rick Ferri draws upon one of our favorite sources to provide real data – success lower than a coin-flip. Why do you suppose that you only hear about a few big calls?
  • Corporate profits should improve. Goldman Sachs economist Jan Hatzius identifies four key reasons. Hatzius is no perma-bull. He was identified by forecasting authority Nate Silver as the economist who "called" the 2008 economic decline at the right time and for the right reason. As always, it pays to follow those whose conclusions change with the evidence. And see another four reasons from Fidelity Investments' team.
  • Don't cry about Argentina. Brian Gilmartin keeps it all in perspective, writing as follows:

    My own opinion is that post-2008, the US Financial System and the European Developed market economies are so much stronger today, thus even if the Argentine devaluation should ripple across Latin America to Brazil, etc, the damage to the SP 500 and the US equity markets should be limited.

  • There were no real surprises. Barry Ritholtz notes the discrepancy between actual data, including earnings, and the change in sentiment. As always, his entire post is well worth the read.

I am shopping for stocks. I have some cash in our long stock program, with a mission that I described in my regular annual preview interview with Seeking Alpha. The interview combines strategy, perspective, and some specific themes. As I often do, I start by emphasizing risk control. I see that as crucial in dealing with the temptations to engage in poor market timing. Several of the themes I mentioned are near the buy points.

Many investors remain cautious about stocks and want to emphasize income. At the request of several readers I wrote up an example of an actual trade, illustrating how you can improve your yield from the stodgier stocks. It does not require a rising market, and provides an extra measure of safety. You can try this at home!

While I am not trying to time a correction, I do have more than a normal cash level, raised through normal trimming. I am actively shopping in the sectors I have highlighted.

And finally, we have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

I do not pretend to know what the markets will do next week. I carefully offer ideas in two time frames, described above. It would not surprise me greatly to see a short-term stock move in either direction.

There are some topics where we can have more confidence.

The Fed is not going to change policy because of Argentina or a minor decline in stocks. Neither is a sign of crisis. The Fed has a dual mandate – price stability and employment in the US. This is tough enough! The Fed will not adjust policy because some market participants have made exaggerated trades in emerging markets. Ed Yardeni has a nice summary of this issue, including this key quote:

3) Fed Chairman Ben Bernanke. In his press conference on September 18, 2013, Fed Chairman Ben Bernanke was asked for his reaction to charges coming out of emerging economies that the Fed's policies have been causing them financial distress. His initial response was that "we're watching that very carefully." Then, he went on to defend the Fed's policies as good for everyone:

The main point, I guess, I would end with, though, is that what we're trying to do with our monetary policy here is, I think, my colleagues in the emerging markets recognize, is trying to create a stronger U.S. economy. And a stronger U.S. economy is one of the most important things that could happen to help the economies of emerging markets. And, again, I think my colleagues in many of the emerging markets appreciate that--notwithstanding some of the effects that they may have felt--that efforts to strengthen the U.S. economy and other advanced economies in Europe and elsewhere ultimately redounds to the benefit of the global economy, including emerging markets as well.

The Fed will remain "data dependent" with a focus on the economy, not the stock market. I would be very surprised to see a change in the Fed "tapering" plan based upon the data we have seen. The modest changes in the strength of stimulus, something that will last for years into the future, make little real difference to the economy.

Those who wish to trade based on the Fed decision are making a guess about the perceptions of others and the short-term market impact.

Author: "oldprof"
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Date: Thursday, 23 Jan 2014 03:43

The insightful investor is skeptical of factoids.

And for good reason!

If you want to use history as a guide, care is required. I thought this was pretty obvious until my morning watching of CNBC in Davos (it doesn't seem the same without Maria) showed Andrew Ross Sorkin interviewing Kenneth Rogoff. This seemed interesting, so I turned off the mute button and backed up the TIVO. Here was someone who could really grill Rogoff about the research findings that are now the source of so much controversy.

What a disappointment! There were no hard-hitting questions. Even worse, Sorkin uncritically accepted as fact a silly bearish idea about the Fed. CNBC has trimmed the interview to exclude that portion, but I have it on TIVO. Sorkin says that whenever there is a new Fed Chair, the market corrects within the next six months.

Let us examine that Factoid.

Background

A couple of weeks ago a Famous Bearish Pundit noted on Twitter than when there was a change in the Fed Chair, the market usually declined. Someone asked the FBP when he expected the correction. He replied that it was not a prediction, it was a fact.

Well!

There is a lot of buzz about not doing predictions, but most of the history cited is offered with that in mind. The basic notion is that history will repeat, and that these simple bivariate relationships are relevant to your trading or investing.

FBP moved on, but here is a source that took up the argument.

The average maximum drawdown in stocks during the first six months of a new Fed Chairman has been 16%. This is consistent with other indicators that suggest an elevated risk of correction as we move through 2014.

Analyzing a Factoid – First Cut

Whenever you are presented with a proposition like this, the insightful investor should be seeking a basis for comparison. Suppose for example, that the maximum drawdown for stocks is ALWAYS 16% over the next six months. In my own work, I always warn investors that this level of change is a normal fluctuation, having nothing to do with the fundamentals of the market. What you really need is a 2 by 2 table, with Fed leadership change and No Fed leadership change on the horizontal axis, traditionally reserved for the independent variable. Then we can see if there is a real difference in results. Should it be average result? Maximum drawdown? What time period?

You can be sure that your pundit will pick the case that favors his viewpoint.

Second Cut

The insightful investor digs a little deeper. I always look at the data. Statistical experts regard this as getting your hands dirtyJ Instead of blindly accepting a statement about changes in the Fed Chair, you ask what data might be relevant. Let us start by looking at the history of changes, from Wikipedia.

 

#

Chairman[7][8]

Years in office

President(s) with whom they served[9]

1

Charles S. Hamlin

August 10, 1914 –
August 19, 1916

Woodrow Wilson

2

William P. G. Harding

August 10, 1916 –
August 9, 1922

Woodrow Wilson
Warren G. Harding

3

Daniel R. Crissinger

May 1, 1923 –
September 15, 1927

Warren G. Harding
Calvin Coolidge

4

Roy A. Young

October 4, 1927 –
August 31, 1930

Calvin Coolidge
Herbert Hoover

5

Eugene Meyer

September 16, 1930 –
May 10, 1933

Herbert Hoover
Franklin D. Roosevelt

6

Eugene R. Black

May 19, 1933 –
August 15, 1934

Franklin D. Roosevelt

7

Marriner S. Eccles

November 15, 1934 –
January 31, 1948[10]

Franklin D. Roosevelt
Harry S. Truman

8

Thomas B. McCabe

April 15, 1948 –
March 31, 1951

Harry S. Truman

9

William McChesney Martin, Jr.

April 2, 1951 –
January 31, 1970

Harry S. Truman
Dwight D. Eisenhower
John F. Kennedy
Lyndon B. Johnson
Richard M. Nixon

10

Arthur F. Burns

February 1, 1970 –
January 31, 1978

Richard M. Nixon
Gerald R. Ford
Jimmy Carter

11

G. William Miller

March 8, 1978 –
August 6, 1979

Jimmy Carter

12

Paul A. Volcker

August 6, 1979 –
August 11, 1987

Jimmy Carter
Ronald W. Reagan

13

Alan Greenspan

August 11, 1987 –
January 31, 2006[11]

Ronald Reagan
George H.W. Bush
Bill Clinton
George W. Bush

14

Ben Bernanke

February 1, 2006 –
January 31, 2014

George W. Bush
Barack Obama

15

Janet Yellen

February 1, 2014 –

Barack Obama

 

Does anyone really think that the depression-era results are meaningful?

It should be obvious that most of this history is totally irrelevant – at least through 1970. Arthur Burns came in to deal with inflation, and it is natural for this to have a negative market effect. Miller had a brief and unhappy tenure. Volcker had a mission like that of Burns. Greenspan came in right before the 1987 crash, which had nothing to do with the change in the Fed Chair.

Any open-minded person who looks at this history should realize that the change in Fed Chair has little to do with stock market prospects.

And to Emphasize

If there were ever an occasion when it made no difference at all, this would be the time. Yellen has been Vice-Chair, supportive of all policies, and pledged to continuation. Bernanke clone is sometimes mentioned, although I personally expect her to show some independence.

Investment Conclusion

My final words will be familiar to regular readers. There is a vast disparity between what is popular in the media and what will help your investments. Popular sources are rewarded for page views and ratings. The average investor is not watching, so the ratings come from a different source.

Of course there could be a market correction – something that pseudo-experts were calling for with assorted messages during all of last year. We will probably see one during 2014. It will have absolutely nothing to do with the transition in the Fed.

The insightful investor knows better!

Author: "oldprof"
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