Markets hate uncertainty, and last week delivered a super-sized portion! Do not expect much clarity in the week ahead.
Last week I predicted that fear might beget more fear. Starting with Secretary of State Kerry's Monday press conference the markets moved lower. Tuesday trading exacerbated the effect, and the market did not recover. Rarely has one of my weekly previews been so accurate, so quickly, and for the right reason.
It is a classic case of confusing fear and risk, something I tried to clarify in this post. The fear part is pretty obvious, as we saw frightened individual investors stampeding out of stocks, especially the broad market ETFs. Steven Russolillo reports the story, noting that it is the largest monthly outflow in five years. In sharp contrast, the objective risk measures that we document each week (see below) have moved only slightly higher. For a market-based analysis of Syria, check out Scott Grannis, who asks, How Scary is Syria?
Bespoke offers their own risk indicator - a CDS index - in their post, Credit Markets Not Too Worried.
Dimensions of the Syria Issue
This is a fascinating case study, with big stakes on many fronts. President Obama's decision to seek Congressional approval for action caused me to scrap my theme for today's post and to reconsider my own plan for the week. Here is a good analysis of the probable factors at work.
- Citizen. As citizens, we should all be interested and informed. If you feel the need to catch up, do not be embarrassed about enjoying your summer vacation. Here is a good source to catch up.
- Analyst of Presidential Power. This one has not gotten much mention so far. Every schoolboy knows that Congress has the power to declare war. Most college students know that modern wars never had a declaration. Some of them had rather vague Congressional authorizations. Check out the Tonkin Gulf Resolution, which provided some justification for the Vietnam War. If President Obama seems to be ceding power to Congress, it will represent a major shift.
- Political junkies. This is a field day for political pundits and especially for Obama opponents. He can be criticized for moving too quickly or too slowly. He was attacked via Twitter (just what we need - debating points in 140 characters) for acting without Congressional support. He is already being attacked for soliciting it.
- US role and moral responsibility. There is widespread agreement about using weapons of mass destruction, especially against civilians. Identifying the culprits and finding a course of action is much more challenging. In particular, what should the US role be? What allied or UN support is required? What level of reaction is appropriate?
- Investor analysis. Next to the other major dimensions, the investing question seems less significant and a bit tawdry. So be it. Each of us must separate our role as citizen from our role as investor, finding the right answer for each. Oil markets and stocks seem to be reflecting - at least partially - something much more significant than a one-time US strike against Syria. The uncertainty involves possible involvement by Iran (against Israel?) or China. While these possibilities may be unlikely, they are prominently mentioned. This theme of fear and uncertainty will continue, since Congress will not return from recess until September 9th. Even then, there is a good chance that Congress will reject action.
Other Uncertainties Loom
Syria is not the only question for the markets. There is an autumn of uncertainty, as noted by Joe Weisenthal. We can expect a lot of discussion about end-of-year positioning for investors. As usual, the cloudier the crystal ball, the more fun it is for the pundits!
I have some thoughts about post Labor Day positioning, and my suggestions for the best sources. I'll report in the conclusion. First, let us do our regular update of last week's news and data.
Background on "Weighing the Week Ahead"
There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results, you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios. Each week, I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.
My record is pretty good. If you review the list of titles, it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topic the week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.
This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!
Last Week's Data
Each week, I broke down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
- It is better than expectations.
There was some significant good news last week.
- Q2 GDP was revised higher. While this is backward looking, it does provide a positive base.
- Ratings for financial TV continue the recent decline. Ryan Detrick explains why this is bullish. (Think the opposite of 2000).
- Underwater mortgages decline. See GEI analysis of Zillow data. Nice interactive graphics.
- PIMCO changes course! Josh Brown nails it with his discussion of PIMCO's complaints about the media, noting some hypocrisy given the media blitz by the firm's top executives. Barry Ritholtz is even more explicit in his post, Proof the Bond Bull is Over: PIMCO Selling Hedge Funds. This is a good discussion of the recent PIMCO moves and the relaxation of SEC restrictions. Can we expect a change in rhetoric from these sources?
- Earnings remain positive. Q2 showed an increase of about 4%. This is a win for earnings guru Brian Gilmartin who forecast 5% or so compared to the 1% loss predicted by Doug Kass, which we documented here. We hope they will both have predictions for next quarter as well. Meanwhile, Ed Yardeni notes that estimates for 2014 show an 11% gain over this year.
- Michigan sentiment made a nice rebound from the mid-month levels. I regard this as a pretty good coincident indicator for spending and employment. You can see the relationship to GDP from Doug Short's fine chart:
- Case-Shiller home prices are up 12% year-over-year. (Via Calculated Risk).
In addition to the Syria story, there was some bad economic news.
- Debt ceiling negotiations between the White House and Senate Republicans (the most important dynamic) are "on the rocks." (See The Hill).
- Personal consumption spending disappointed. (See analysis from Steven Hansen at GEI). Calculated Risk provides this chart:
- Trading glitches. Each of these serves to undermine confidence - perhaps with good reason. The Economist reports on several recent incidents. A new study shows just how costly this can be. Policy changes coming?
- Durable goods orders crashed no matter how you measure the change. Steven Hansen at GEI has the analysis, including this chart:
- Emerging markets continue to decline. Some are suggesting a link between these markets and future world economic issues. These same sources also frequently cite central bank policy as a cause. Ed Yardeni suggests that forward earnings in these countries are more responsible. He also does not see a "panic attack" from the Middle East.
- Pending home sales fell 1.3%, a disappointment. Calculated Risk notes that some signings may have been pushed forward because of mortgage rates. (Contra Todd Sullivan, whose chart suggests normal seasonality).
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.
This week's award goes to Derek Thompson writing at The Atlantic. Remember all of those recent stories about how 1/3 of young adults were living at home? It turns out that a dorm room counts as "home" in these measurements. That is only one of the three factors making this into a misleading story.
The Indicator Snapshot
It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:
- For financial risk, the St. Louis Financial Stress Index.
- An updated analysis of recession probability from key sources.
- For market trends, the key measures from our "Felix" ETF model.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator, our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
I feature the C-Score, a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." In this series of videos, Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for the specific recession that concerns them. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.
I have promised another installment on how I use Bob's information to improve investing. It has been on my "important but not urgent" list, since I am not currently worried about a recession. Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.
I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration. Dwaine has also developed a market-timing approach which follows ten bear-market signals. His latest installment provides detail and a current look.
Georg Vrba's four-input recession indicator is also benign. "Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon." Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals. For those interested in gold, he has a recent update, asking when there will be a fresh buy signal.
Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage of the ECRI recession prediction, now almost two years old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating. These are showing some recent weakness, so let us take a look at the chart.
We can see that the recent real income data has been weak, and the overall growth has been modest. There is still nothing resembling a business cycle peak and a significant pull back, which is the NBER definition for a recession.
The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.
Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. A few weeks ago, we briefly switched to a bullish position, but it was a close call. While we are currently "neutral," Felix might switch to a bearish posture if the overall market drifts lower. The inverse ETFs are more highly rated than positive sectors by a small margin, but remain in the penalty box. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings seem to have stabilized at a low level. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.
[For more on Felix or the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (FREE) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
This week brings plenty of news and data, including some important reports.
The "A List" includes the following:
- The employment situation report (F). This is the biggest data point for the week, and a key factor for some of the FOMC members.
- Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. It shows only job losses, not gains, so the monthly employment data are more important when available.
- ISM index (T). The calendar quirk pushed this important concurrent indicator into next week. It is important for employment forecasts and overall economic growth.
The "B List" includes the following:
- ADP jobs Data (Th). This might actually be better than the official numbers for private employment, although it does not get the respect. Economists will adjust Friday estimates based upon this report.
- Beige book (W). The anecdotal evidence for the next Fed meeting will get extra scrutiny this week.
- Auto sales (W). Vehicle sales are seen as a good indicator of consumer spending, and truck sales as an independent indicator of economic activity in construction and small business.
- Trade balance (W). Followed more closely as a factor in GDP calculations.
- Factory orders (Th). Expected to be pretty weak.
- Construction spending. Everything related to construction is interesting, especially with interest rates rising.
There are also some Fed speeches, including some of the more hawkish members. There will be plenty of sounding off about Syria. President Obama will be in Russia for the G20 meetings, generating unpredictable economic and political news.
You can see why I expect volatility rather than clarity.
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 a neutral posture, now fully reflected in trading accounts which have only a position in gold miners. The overall ratings are slightly negative, so we are close to an outright bearish call. This could easily be the case by the end of next week. While it is a three-week forecast, we update the model every day and trade accordingly. It is fair to say that Felix is cautious about the next few weeks. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens. The signals have basically lacked a clear direction for most of the summer.
Insight for Investors
The challenge for investors is to distinguish between the major trends and the short-term uncertainty. The main themes are not related to headlines news, even though sentiment may drive market fluctuations. Do not be seduced by the idea that you can time the market, calling every 10% correction. Many claim this ability, but few have a documented record to prove it. Most who claim past success are using a back-tested model. Please see The Seduction of Market Timing.
Here are the key concepts.
- Beware of yield plays. For several months, I have accurately emphasized the danger of yield-based investments - yesterday's source of safety. The popular name for this is "The Great Rotation." It is still in the early innings, since bond fund investors are only getting the bad news from their statements. Even the best bond managers (like Gross and Gundlach) cannot win when interest rates are rising. The exodus from their funds is starting. Most investors are emphasizing cash, real estate, and gold. .333 is good in the major leagues, but not for your investments!
It may be a "generational selling opportunity" for bonds. I locked in some positions after the recent big move, but this story is not over.
- Find a safer source of yield: Take what the market is giving you!
For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. (I freely share how we do it and you can try it yourself. Follow here).
Last week provided chances to set new positions on down days and also to sell calls against existing energy positions on the Syria news. Take what is offered each day.
- Lose the focus on fear! Many are rewarded for making sure that you are "scared witless" (TM OldProf euphemism). If you are addicted to gold and allegedly safe yield stocks, you need a checkup. Gold works in times of hyperinflation or deflation/crisis. When neither happens, the ball is going between these Golden Goalposts. There is a good transition plan for those with a fixation and fear of gold.
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).
It is often a challenge for investors to keep an unemotional, data-based perspective when the headlines are all related to the latest crisis. In the WTWA series, I have an emphasis on recent developments. It is also important to do a broader assessment on occasion. Everyone should take a few minutes to review Scott Grannis's 20 optimistic charts. He writes as follows:
"I continue to believe that the market is dominated by pessimism rather than optimism. Or, if you will, that there is a shortage of optimism.
What follows are some 20 or so charts, in random order, which highlight optimistic developments in the economy and financial markets which I believe are underappreciated. They paint a picture of an economy that is stronger and more durable than the skeptics seem to believe. There's still plenty of room for improvement, to be sure, but there are few if any signs of deterioration."
These are all interesting indicators, not contrived with some pre-conceived conclusion in mind. Here is just one example.
Interestingly, this all puts me at odds with my fellow Seeking Alpha contributor, James Kostohyrz, who is bullish for the short term but sees a bubble forming. My own view is the opposite on both counts. We shall see....