Sometimes the political and economic streams converge to determine the agenda.
Prepare for a non-stop debate about jobs.
This week the major data all relate to employment. We also have the first of the Presidential debates, Wednesday night at 9:00 PM EDT. Moderator Jim Lehrer, whom I met when he got an honorary degree in my professor days, has released the topics for the debate and also devised an interesting format. There will be plenty of opportunity for discussion and following up. Neither candidate can expect to give a prepared answer and stick to the script while dodging the main points -- especially with Lehrer in charge!
The debate will start with a discussion of economic policy. Employment will be at the forefront. Both campaigns are engaged in driving down expectations. Two examples: "Obama is a great orator." "Romney has so much recent experience and won most of the primary debates."
It is a tricky game. You have to praise your opponent so much that any outcome seems good for your side. You must do so in a way that belittles debating skills as not relevant to the actual job. Check out The Hill's report for details.
I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.
Background on "Weighing the Week Ahead"
There are many good sources for a list of upcoming events. One source I especially like is the weekly post from the WSJ's Market Beat blog.
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.
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 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:
- 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 were a few bright spots last week.
- Greece has a coalition proposal for a new austerity package (see The New Athenian). This is a good step. Next we must see whether it will pass muster with "the troika" in charge of bailout funding.
- Housing prices are stronger -- now on all indexes as reported by Bonddad. Calculated Risk looks at prices measured in several ways, with plenty of great charts. Here is the simple version, just using nominal prices (click to enlarge images):
- M2 growth has resumed. This is the foundation for economic improvement through expansionary Fed policy, so it deserves attention. Bonddad reports the y-o-y growth of 7.1% as well as positive readings from their valuable regular coverage of high frequency data.
- Spain made progress. This complex story was misinterpreted by many, especially because of the video coverage of demonstrations. The market wants Spain to agree to a bailout, get lower interest rates, and achieve some certainty. This is a difficult political step, so it is not happening as quickly as pundits would prefer.
- Initial jobless claims moved lower. The 359K report is back to July levels and much better than the more worrisome 380K range of recent weeks. The reported data does not include the survey period for this week's payroll report.
- Consumer confidence spiked higher. The Conference Board measure bounced to 70.3, much higher than expectations. This is encouraging as a coincident indicator of employment as well as possible future consumption. Here is Doug Short's chart, showing that levels are still below normal expectations:
There was plenty of bad news last week.
- New Home sales were soft, down 1.9% month-over-month, but up 24% year-over year. See John Lounsbury and Steven Hansen's discussion.
- Earnings forecasts moved lower. Reacting to second-quarter reports and outlook, analysts have reduced forecasts. Brian Gilmartin tracks this carefully, showing the actual changes by sector as well as some thoughtful commentary. One-year forward earnings have not moved that much. Bespoke wonders whether the bar is now low enough for Q3. Here is their typically helpful chart:
- Durable goods orders declined by 13.6%. Even excluding the transportation segment with the high volatility airline orders, the decline was 1.6%, much worse than expected. See Steven Hansen's discussion and helpful charts. Here is one example:
- Chicago PMI broke below 50. The 49.7 reading indicates marginal contraction in manufacturing for the Chicago region. Normally this report gets less attention, but it moved the market on a Friday morning. Many view this as an indicator of the national ISM report which will be released on Monday.
- Business investment is weak reflecting lower confidence. Scott Grannis discusses and provides this chart:
Iran's progress toward nuclear weapons. Just as importantly, Israeli perceptions of Iran's progress. See Israeli Prime Minister Netanyahu's UN General Assembly Speech.
The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
- The St. Louis Financial Stress Index.
- The key measures from our "Felix" ETF model.
- An updated analysis of recession probability.
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. 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.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."
Bob and I recently did some videos explaining the recession history. I am working on a post that will show how to use this method. As I have written for many months, there is no imminent recession concern. I recently showed the significance of by explaining the relationship to the business cycle.
The ECRI recession call is now over a year old. Many have forgotten that at the time of the original prediction, the ECRI claimed that the recession was already underway by September of 2011. See New Deal Democrat's carefully documented discussion, including the original video, at the Bonddad Blog.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.
The single best resource for the ECRI call and the ongoing debate is Doug Short. This week's article describes the complete history, the critics, and how it has played out. We are now seeing modest declines in two of the major indicators. Here is the key chart:
The Doug Short updates are mandatory weekly reads for those who are still worried about a new recession.
[We did not get our regular data for the RecessionAlert forecast, but hope to update this next week.]
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. This week we continued as bullish after a brief stint at "neutral." These are one-month forecasts for the poll, but Felix has a three-week horizon. The ratings have moved a little higher, and the confidence has improved from last week. It has been a close call over the last few weeks.
The Week Ahead
There are not so many items on this week's calendar, but it is a crucial week. As noted above, my grading of the reports relates to what I see as important.
The "A List" includes the following:
- The Employment Situation Report (F). Right or wrong, this will be viewed as the official indicator of where the US economy stands.
- Initial claims (Th) which continue to provide the most up-to-date read on jobs and the economy.
- The ISM manufacturing report (M) is expected to be weak, but remains a wild card. This has implications for Friday's employment report.
The "B List" includes several reports:
- ADP jobs estimate (W) may actually be as good as the official report, but does not enjoy the same status.
- The ISM services index (W) does not have the long history of the manufacturing index, but now represents a more important part of the economy.
- The FOMC minutes (W) may seem like old news, but provide some color.
The Presidential debate will be big news, but challenging to interpret. Pundits will speculate both on who won and also the implications for the economy.
There is a lot to cover this week, but I'll try to do something on debate night.
Trading Time Frame
Felix has moved back into a neutral posture after a few weeks as marginally bullish. It has been a close call for several weeks. In practice, the official forecast has mattered little to our trading positions. Felix became more aggressive in a timely fashion, near the start of the summer rally. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. The ratings have moved lower this week, and I would not be surprised to see a reduction in trading positions this week.
Investor Time Frame
Last week I reported on research showing that many long-term investors have simply lost touch with reality. I see confirmation in data showing that investors have abandoned stocks.
Even the PBS Newshour program, exceptionally aimed at balance and information on topics like this, winds up with a pairing of two people celebrated by those of the bearish persuasion -- Harvard's Econ and Public Policy Prof Kenneth Rogoff and PIMCO's Mohamed El-Erian. Neither seemed especially bearish in this interview, perhaps because of the setting.
Rogoff, whose recent book as frequently cited as proof positive that the end is near for the US economy, responded as follows:
I do think next year might look a little better. But I don't think we're going to be having fast growth for a very long time. The uncertainty around the world, in Europe, in the United States, in China is one thing.
The huge debt legacy from the financial crisis is another and the growing government debt.
That said, I mean, I wouldn't underestimate the upside, with the U.S. being such a creative economy. For example, energy prices have fallen a lot. And there are some other things you can point to on the upside.
But, so far, businesses have been very reluctant to invest heavily, very reluctant to hire heavily.
El-Erian had the following comment:
I tell the politicians, please remove the fiscal cliff, because if the fiscal cliff occurs, and we get 4 percent of GDP disorderly cuts in spending and then across-the-board increase in taxes, the U.S. will go into recession.
So, the first thing is, do no harm.
Second is, if we can get over that, I see an economy gradually picking up momentum. It's not going to be great. We're going to -- we're going to create jobs, not enough to really lower the unemployment issue. And, hopefully, we're going to start dealing with these longer-term issues.
So, like Ken, the thing I find most frustrating, Judy, is this is not a complicated issue. We can handle this. We can unleash the innovation, the entrepreneurship, the cash that is on the sideline. But it requires a political will and political coordination.
I watched the show and decided to do a one-person focus interview -- not a poll - with one of the smartest people I know. He is a regular Newshour viewer and had just watched the interview. He understood the background and biases of the participants. He has personally beaten the markets and the pundits by choosing and maintaining some high-quality investments and discounting the headline worries.
Since he is a Poli Sci PhD he is not scared witless (TM euphemism OldProf) by news from Europe. He is accustomed to progress through incremental processes. While I am delighted that my friend is doing so well, I suspect that most investors do not share his savvy.
The Risk/Reward Question. How much risk should you take? The right answer is different for everyone, but too many people choose "zero." These investors do not follow the Buffett advice of buying when others are fearful. Then, when the market rallies, they are afraid that they are "too late." I wrote a recent article, Stock Prices and the Fundamentals: Don't be Fooled, showing how to avoid this trap. The answer is not going "all in" since most of us have to pay more attention to short-term risk than does Mr. Buffett!
If you have been following our regular advice, you have done the following:
- Replaced your bond mutual funds with individual bonds (bond funds are very risky!);
- Sold some calls against your modest dividend stocks to enhance yield to the 10% range; and
- Added some octane with a reasonable allocation of good stocks.
There is nothing more satisfying than getting yield and call premiums, even if stocks move sideways.
If you have not done so, it is certainly not too late. 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!)
Final Thoughts on Employment
Current economic data reflect the weakness in business investment. While consumer confidence is higher, business confidence is still lacking. I am specifically referring to established businesses considering expansion --- and I do not mean all of them. At the margin, there are some businesses that simply find it easier to be conservative, waiting until after the election to commit to expansion or new hiring. This is the key source of the recent soft patch in manufacturing.
Companies have no incentive to make positive earnings forecasts and may well choose to delay expansion. It is the price we pay for a political process that creates long periods of uncertainty with brief windows of opportunity for fixing problems.
The jobs picture is actually a little better than we thought. This week the BLS announced the preliminary benchmark revisions for payroll employment. Net job creation was actually about 350K better than previously reported and private job creation was 400K better for the twelve months ending in March, 2012.
Here are the key takeaways:
- Those disparaging the BLS estimate as adding phantom jobs have once again been proved wrong. The basic process has been very accurate over the years, with an average error of only 0.3%. You should be hearing a correction from some commentators, but do not hold your breath!
- Revising data is a fact of life. Consumers demand timely reports, which use partial data and estimates. When complete data become available, the BLS reports it, as we would expect. The smart-Alec know-nothings who have never had the responsibility of developing data use this as an occasion for criticism. When you read someone making a sarcastic comment about the BLS suddenly "finding" another 350K jobs, you have discovered a biased and misleading source of commentary.
I am not expecting major job gains, especially given the other indicators and the manufacturing weakness. I will discuss this further in my regular monthly employment preview.
Enjoy Wednesday's debate, which will definitely not be using any replacement referees!