Weighing the Week Ahead: All Eyes on Energy Prices

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Includes: DIA, IYE, QQQ, SPY
by: Jeff Miller

Last week's jobs report provided evidence of continuing economic improvement -- finally including employment. The biggest challenge is the recent spike in energy prices. The energy threat is undermining consumer confidence and perhaps spending. The cost of energy inputs may compete with business spending for investment. Finally, and most important for some, is the chance that energy costs will force a change in Fed policy.

I also have a parallel theme this week. I spent two days at the Kauffman Foundation's Economics Bloggers Forum. It is an interesting collection of academic economists, journalists, finance bloggers, entrepreneurs, and think-tank types. It would be difficult to find a group with a higher concentration of advanced degrees from top institutions. It would be equally difficult to find people more hard-working and dedicated. The richness of ideas and the productivity are both impressive.

I find this to be an invigorating and inspirational experience. I love mixing it up with really talented people with differing perspectives and hearing about their newest ideas. It is a compelling intellectual stew that could not be accomplished any other way. There is an openness and respect accorded to everyone -- a willingness to consider diffrering viewpoints.

I have a long list of Kauffman-inspired ideas, and I'll start with some references in this article.

Background on "Weighing the Week Ahead"

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is 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.

In most of my articles I build a careful case for each point. My purpose here is different. 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 some will disagree. That is what makes a market!

Last Week's Data

The most important economic data were positive.

The Good

For several weeks I have commented that there is growing recognition that the economic rally now has a self-sustaining character. Occasionally I get a question or comment that reminds me I need to explain this more clearly. Reader J.Q. observes that deficits mount, interest rates are still near-zero, millions of lost jobs have not been regained, and there is no housing bottom.

So let me emphasize: A self-sustaining recovery (some are calling it "escape velocity") means that we are reaching a point where economic growth will not depend upon stimulus. It does not mean that all is well. Growth is still below trend and many problems remain. I point this out every week. Investors need to think about the direction of changes. There is always a list of worries, well-known and factored into the market. If there were no worries, the Dow would already be at 20K.

This is why I insist on looking at weekly changes in important indicators.

  • The Employment Report continued a pattern of solid improvement, better than I expected. The 216K growth in net payroll jobs is finally better than the level needed to offset growth in the labor force (100-125K). The unemployment rate, to the surprise of many, stayed at 8.8%. At some point there may be an expansion in the labor force sending rates higher despite solid job growth. The Kauffman attendees were covering this report by putting in some very long days.

Dean Baker covered the morning release, did a fine presentation about the effect of patent policies on prescription drug costs and a possible solution, and was writing again as soon as he got home. He provides some needed perspective on how far we have to go in his insightful labor-force adjusted chart. After a brief night's sleep, he was writing again, challenging the mainstream interpretation of this report. I enjoyed meeting him and discussing various economic topics as well as our Michigan roots (grad school for both of us). He is very astute with both analysis and data, as one would expect from his work. I agree with his interpretation, although I am probably more optimistic about job creation.

Mark Perry also had an early blog post on the jobs report, noting that we were back to a 15-month job creation record equal to the time before the recession. (I was able to observe his technique in finding data and swiftly creating the charts we all expect from him.) He is known for finding a slant overlooked by everyone else. He has a good observation that the employment gains were concentrated among women. I was impressed with Mark's dedication as well as his ability to find and explain important data.

Mish was also hard at work. His article acknowledged improvement on the jobs front and also clarified some information about the birth/death adjustment. In the wee hours he was on to the same theme as Mark Perry -- gains among women. While discussing matters in the hotel bar, I think I got him to agree that he had been too tough on the BLS. We also had a lively discussion about whether political viewpoints should play a part in investment blogging. I'll say this about Mish -- he has both passion and blogging integrity (fairness in quoting, links, and accepting responsibility).

  • The ISM report was 61.2, roughly in line with expectations, but a small downtick. This report is consistent with real GDP growth of about 6.5%. This makes me skeptical of those who see the second derivative on ISM as a significant indicator. This is a topic for another day.
  • Technical indicators. Charles Kirk notes that many technical methods now have buy signals, and he has moved to a neutral posture. There was also a Dow Theory buy signal last week.
  • Profit Margins are expanding. Dirk Van Dijk of Zacks continues to lead on this story. There is a popular theme that margins will revert to the mean. These predictions are no doubt correct, but they have already been too early and might continue to be wrong for years.
  • Economic growth forecasts improved. The ECRI Weekly Leading Index improved slightly, to 130. The growth index also moved higher to 6.5%. These continue to be good readings, but everyone is watching the indicator closely.
  • Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to +.024, a bit lower than last week's +.155. These are completely normal readings for a scale measured in standard deviations from the norm. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.

NB: The ECRI and SLFSI are actually readings from week-old data.

The Bad

The bad news was mostly political.

  • Energy prices move higher. This is a big threat to the economy.
  • Middle East and Northern Africa issues continue to dominate the news. No one really knows how far unrest might spread. The desire for democracy may be in conflict with economic goals.
  • Popular scare tactics. I was disappointed that George Will, normally an honest source, engaged in a facile misrepresentation of the Fed and US bond offerings. Perhaps he was just deceived by Bill Gross's misleading commentary.
  • Political posturing on the government shutdown continued. The incentives for individual members differs from the need of the public.

The Ugly

The ugliest news this week was the selfish assertion of First Amendment rights that needlessly cost the lives of innocent people in Afghanistan. I am not going to mention the name of this publicity-seeking zealot, but there has been a universal condemnation of his religious book-burning affront. This guy has already outlived his fifteen minutes of fame.

The Sign of the End for Financial Advice

I was suspiscious of a headline asserting that someone called "Snooki" had been recruited to blog about financial problems. While I am vaguely aware of Snooki, I have never watched her reality show. I was quite confident that the article snippet was wrong in asserting that it was a feature on PBS. No way.

Like all good spoofs, the story has a modicum of face validity. Rutgers had paid her $32,000 for a speaking engagement, about what she gets for an episode of her show. The SAT now has a Snooki essay question. If Lenny Dykstra can be celebrated as an investment expert, why not Snooki?

Fortunately, it is just a clever April Fool's story. Check out the entire article for a good laugh.

Our Own Forecast

We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned much more cautious. We are continuing our neutral posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on the near-zero ratings for the various index ETFs, which do not at this time suggest selling short. Here is what we see:

  • 55% of our 56 ETF's have a positive rating, up from 29% last week. This breaks the downward trend.
  • 93% of our 56 sectors are in our "penalty box," about the same as 95% last week. This is an indication of very high short-term risk.
  • Our universe has a median strength of +21, up dramatically from -23 last week.

The overall picture improved last week. We increased positions in trading accounts to 40%, holding only the two strongest sectors.

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

The Week Ahead

It is a light week for data.

The unpredictable events in the Middle East will continue to affect oil prices. The current levels are already having an effect on confidence and spending. This may be the biggest current economic threat. There is no sound method for predicting the outcome. I do hold energy stocks as a hedge and because of attractive values.

I have a standing prediction that the government shutdown will be avoided, and I am sticking to that position. Leaders of both parties understand that the American people expect government operations to continue and would blame both sides equally. This provides a strong incentive to negotiate, and I expect the bargaining to avoid a shutdown. Were a shutdown to occur, it would be another huge element of uncertainty, an end to necessary payments and services, a drop in confidence, a loss of economic activity, and a major market negative. This might stretch out until Friday.

The Fed minutes will attract some attention. Despite the dissenting statements from some Fed members, I do not expect an imminent reaction to higher food and energy prices. I understand that many disagree with the Fed methods, but that will not change the policy.

Investment Implications

My current market viewpoint is still sharply divided, depending upon the time frame. The near-term is risky, so it pays to be cautious.

I recommend this week's Barron's interview with Barry Knapp, the head strategist for Barclays. The article suggests that he combines academic and trading credentials, something I find to be quite useful. Rarely have I read an article where I find myself so much in agreement with the conclusions.

The title is Playing into a Cyclical Recovery. It hits many themes that will be familiar to readers of this site. Check it out.