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It is time to make an assessment. Whether you are an investor or a trader you need to ask three questions:

  1. How am I doing?
  2. Is my method working in a time of extreme volatility?
  3. If I expect continued volatility, should I change my approach?

After another week of record-level volatility, these are fair questions. Here is an excellent perspective from two sources (via Abnormal Returns -- finding the best articles for us, day after day). From Dynamic Hedge we see what I will call the opportunity. This chart shows how well you might have done if you understood when ranges were broken and when they would hold. Click to enlarge:

Ginormous_ranges_SP2011

In the real world, this is very difficult to capture.

Carl Futia "tells it like it is:"

But we cannot trade the past. We can only make profits betting on the future. And people who bet on future price fluctuations must necessarily rely on very, very cloudy crystal balls. So as a practical matter you should count yourself fortunate indeed if you consistently capture a small part of any given market swing.

Carl has some additional excellent advice:

Markets move up and down, sometimes quite violently. People tend to evaluate their trading performance not simply in terms of profit and loss but also in terms of how much money they could have made had they been able to catch a substantial part of most of the market's up and down swings. In fact, I have known profitable traders who were constantly frustrated and unhappy because they felt that they had left so much money on the table.

I do not pretend to capture these huge swings, but it has been a good time for our various programs. I will offer some ideas in the conclusion. First let us do our regular review of data from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a comprehensive weekly review. My mission is different. I single out what will be most important in the coming week. 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.

Unlike my other articles I am not trying to develop a focused, logical argument with supporting data on a single theme. I am sharing conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am trying to put the news in context.

Readers often disagree with my conclusions. (A commenter recently suggested that was proof that I was wrong -- an amazing interpretation!) Do not be bashful. Join in and comment about what we should expect. 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

The economic and earnings news was pretty good, but once again, Europe headlines dominated over anything else.

The Good

The economic story showed continuing improvement.

  • Leadership changes in Greece and Italy provided greater assurance that agreed austerity targets would be met. There seems to be an increased focus on the substance of needed policy with less attention to the political consequences.
  • Job openings moved up significantly in September, from 3.1 million to 3.4 million.
  • Rail traffic strength shows that a recession is "not imminent" according to Steven Hansen. I recommend reading the entire article for a look at some good charts as well as an exaplantion of why we should focus on containers and not coal or grain.
  • Initial jobless claims and Michigan sentiment -- both better than expected, but neither at a really desirable level. I am scoring them as "good" because of the improvement, but I continue to monitor both quite closely. The jobless claims reflect job destruction. The Michigan index has historically had a good correlation with job creation. The usefulness for that purpose has been lessened by the effect of fuel prices and the damage done by the debt limit debate. Despite these problems, progress is good. My favorite chart on the Michigan survey is from Doug Short. It pulls together several key variables in one image. I encourage you to read the entire article for great analysis and comparison to other sentiment measures. Click to enlarge:

Michigan-consumer-sentiment-index

And the jobless claims chart from Scott Grannis. Click to enlarge:

Screen Shot 2011-11-10 at 9.23.29 AM

The Bad

There was some negative news on all fronts.

  • The bad news from Europe was the spike above 7% in Italian ten-year bond rates. While the yield retreated on Friday, the signal is important to many. Some margin rules take effect at this level. Higher rates make rolling debt more difficult. Banks holding the paper have less collateral for loans. And finally, traders have noted that the 7% level seemed to presage the need for a bailout and bond haircuts in Greece. This can be argued, of course, but the perception is there.
  • French yields also crept higher. This is a concern for those sensitive to any hint of contagion.
  • The Congressional Supercommittee charged with deficit reduction seems stalled. There is plenty of posturing and finger-pointing, with no sign of progress. I am scoring this in the "bad" category, but I still expect them to meet the minimum requirements by November 23rd.
  • Home prices moved 1.1% lower in the CoreLogic index. See Calculated Risk for a good chart and analysis.
  • Delay on the Keystone Pipeline. At least it was not killed completely. Check out Prof. Hamilton at Econbrowser (the go-to economist on oil issues) for his comments and links.

The Ugly

Oil prices and Iran. Oil prices have bounced back to the economic choke point. While The Bonddad Blog reported that most indicators were positive for the week, here was their comment on oil:

Finally, the Oil choke collar engaged after just a few weeks of relatively good news. Oil closed over $99 a barrel on Friday. This is back above the recession-trigger level calculated by analyst Steve Kopits. Gas at the pump declined $.03 to $3.42 a gallon. Measured this way, we probably are still about $.15 above the 2008 recession trigger level. Gasoline usage is once again off substantially, down -4.3% YoY, at 8671 M gallons vs. 9056 M a year ago. The 4 week moving average is off 5.5%. This is the steepest YoY drop yet in that average, and may be evidence that consumers have permanently altered their gasoline usage habits towards more conservation.

The International Atomic Energy Agency "accuses Iran of developing miniaturized nuclear warheads, built for delivery by medium-range missiles. Iran could have enough fissile material, if enriched to weapons grade, for four nuclear bombs." ETF Daily News has an interesting analysis, suggesting that oil prices could go to $200/barrel depending upon reactions to this threat.

Unlike many other well-documented risks, this one does not get much attention, so it may not be "in the market" already.

The Indicator Snapshot

It is important to keep the weekly news in perspective. My weekly indicator snapshot includes important summary indicators:

  • An Economic/Recession Indicator. I am evaluating several candidates. None confirm the ECRI forecast of an inevitable and imminent recession. I hope to have the final verdict this week.
  • The St. Louis Fed Stress Index
  • 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 moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution.

There will soon be at least one new indicator, and the current choices are still under review. I note that the Cleveland Fed has a Financial Stess Index using a strong approach that differs from the St. Louis Fed's. Click to enlarge:

Indicator Snapshot 11-11-11

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. We voted "Neutral" this week.

[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

Who knows what will happen in Europe? The swings from Europe headlines are so great that everything else seems irrelevant. Eventually, owning stocks with attractive prices and solid earnings growth will pay off. Monitoring economic data helps with that, and we look forward to a big week on that front.

We are in the open period for Fed speeches, and plenty of them are on tap this week. These will be watched closely to get a read on any dissent from the Bernanke line and any hint of more aggressive Fed action. Most market participants are looking for any hint of further QE's.

The PPI and CPI data (Tuesday and Wednesday) will not matter unless significantly higher than expectations, especially in core rates. This would suggest pressure on the Fed.

The Empire State (Tues) and Philly Fed (Thurs) Indexes are not very important unless there is an extreme reading. Since we have had a few such moves recently, everyone will be watching.

We have data on retail sales (Tues) and industrial production (Wed). These are pieces to the economic puzzle because of the relationship to GDP, but other sources often provide faster indications.

From the housing data on Friday, I prefer looking at building permits for a true leading indicator. The official release of "leading indicators" does not seem to generate much response, although some see this as a good recession forecasting gauge.

As always, I will be watching initial claims -- hard data, relatively recent, and related to a question of crucial interest.

Do you want to have the full list of everything? Economic reports, Fed speeches, earnings, and now including speeches by your favorite European leader! Check out and save for daily reference the weekly preview from Mark Gongloff.

Trading Time Frame

Our trading accounts were fully invested last week, but with no exposure to US equities. We were invested in oil, REITs, and emerging markets, all of which did well. Inverse ETFs on the US market continue to have high ratings, but have not triggered yet in the trading system. This program has a three-week time horizon.

Investor Time Frame

Long-term investors should continue to watch the SLFSI. Even for those of us who see many attractive stocks, it is important to pay attention to risk. A month or so ago we reduced position sizes because of the elevated SLFSI. The index has now pulled back out of our "trigger range," but it is still high. We have some cash in these accounts, and will use volatility to establish new positions.

When you look back with perfect hindsight, you might have wanted to be "all in" at the point of maximum risk. That is how it always seems. The true lesson is that if your position is too big, you cannot ride out the bad times.

The Final Word

The best way to profit from the Europe-induced volatility has been to embrace it and use it. I have written a series of articles on this theme. All of the concepts have been working. It is a great time for investors seeking enhanced yield with modest risk. These are all ideas that have been working and are still timely.

  • Finding contrarian themes as a first step in stock picking. Readers did a great job on this one, finding additional themes and also stock ideas.

I am not alone. Increasing stock exposure in the face of these worries is Barry Ritholtz, who expects a "grind up" market. He advises avoiding the flip/flop trading of "risk on and risk off."

I agree. Find something that is right for the times and stick with it. Quoted by Mark Gongloff in a very helpful weekly summary article, Art Cashin observed:

Markets breathed a sigh of relief yesterday, not because we’d found a solution but because Europe had awakened. The hard parts are still ahead. That’s why markets in Europe closed mixed yesterday. … Next week could be very interesting.

Art has the pulse of the trading floor.

Source: Weighing The Week Ahead: Will The Volatility Continue?