"Common sense is genius dressed in its working clothes."
There have been times where I have witnessed the tendency to search for, interpret, favor, and recall information in a way that confirms one's preexisting beliefs or hypotheses, while giving disproportionately less consideration to alternative possibilities. What you just read is the definition of confirmation bias. When an investor begins with preconceived notions, then follows that up with what I just described, they have conjured up a brew that will be poison to their investment portfolios.
Time after time we have seen that play out in this old, tired, ready to crumble (sarcasm intended) bull market. Each time it has surfaced, those that have followed that path have been left wondering what is going on. The latest example, 2016. Last year showed how tightly most of us cling to our preconceived notions, how fiercely we resist evidence that we might be wrong and how adept we are at deluding ourselves into thinking we were right all along.
When stocks fell early last year, and every negative was tossed around, not many stopped to view all of the information that was out there. Nor did they take the time to question it. The graphic below shows how the market has followed the basic stair step pattern in the last twelve months.
Every step in that picture was met with what many had already decided was undeniable fact. Remarks last January that the downtrend was firmly in place, and the weakness just had to continue were abundant. Any rally off the lows was labeled a dead cat bounce.
It is fairly easy to see now how confirmation bias crept in, although I am sure that some will still deny what is going on in the equity markets to this very day. At the time it was happening, far too many refused to see the data that showed an alternative to the doom narrative every time the market ran into trouble. Brexit, the Presidential campaign and subsequent election completed the pattern above.
Funny how we didn't hear too many alternatives when the Brexit vote came in, the conclusion was that global markets had to go down. Next up was the idea that a Trump victory would surely end this Fed induced mirage of a bull market (Sarcasm intended), and no pundit or media analyst offered a different outlook. In the meantime, the equity market jumped to new highs.
Please look at that chart, then come back and look at it again. That graphic depicts one of the strongest patterns that an individual stock or market can portray. There is no parabolic move that would call for an immediate and powerful reversal. If one wants to argue that the strong upward spikes are parabolic, so be it, but notice how they are worked off over time. Each new step is a new high, then a pause before moving on, keeping the underlying forward trend in place.
A book titled, The Rationality Quotient, brings to our attention that rational beliefs "must correspond to the way the world is," not to the way you think the world ought to be. If an investor can't be honest with themselves about the difference between the truth and what they think ought to be true, they may well be intelligent, but they aren't rational.
Translating this to the investing world starts with what I continue to repeat, look at ALL of the data. Listen for signals you might be off base. The keyword is listen, then of course evaluate. This is most important when your strategies are going astray.
One way to accomplish this, set up a log on a spreadsheet. On one side place all of the market positives, the other all of the negatives. One important step, this exercise must be done with an open mind. Check the preconceived notions at the door. Since that is part of what makes us human beings, it is easier said than done. Understand another issue. There will be information that is missed or can't be known in advance, so accept that as part of the learning process. When a piece of info surfaces and you know it has to be wrong, check and double check to ensure that confirmation bias did not creep in.
Practiced successfully, it keeps the winners winning in the long run, and why flexibility and the ability to admit defeat are two traits anyone managing money needs to either already possess or that they need to seriously work on. Good investors tend to be right most of the time. Great investors recognize how often they may be wrong and adjust accordingly.
Deutsche Bank is positive on Mr. Trump and what he may bring to the table regarding GDP growth. The IMF also raised its forecasts for the U.S. economy, reflecting an expected boost from the economic policies of President Trump.
The World Bank estimates Trump's policies of tax cuts, regulatory reforms and infrastructure spending could add up to 0.3% to U.S. GDP this year and 0.8% in 2018, boosting global growth by 0.3% in 2018.
Medley Global Advisors says:
"Such numbers mostly reflect aspirations for some kind of certainty about what lies ahead. Thinks it's a laughable proposition to attach any kind of precision to the end-game impact of a long and messy political process in its infancy."
I think most of us would totally agree. It's one day, one step at a time with no preconceived notions attached.
U.S. household net worth to disposable income has recovered to post recession highs and bodes well for the immediate future.
Chart courtesy of Liz Ann Sonders @LizAnnSonders Jan 9
No wonder confidence is up
Ned Davis Research puts the probability of recession at a 2-year low. Their reasoning agrees with the shape of consumer balance sheets:
"Consumers and businesses remain focused on managing debt. Since 2014, the consumer has taken out 44 cents of new debt per dollar of new disposable income, a third the average from 1980 through 2007."
This has fueled the idea that this cycle cannot be measured by the typical standards that most want to apply. It is why many have been calling for a recession since 2015 as they believed the expansion had to end.
The fourth-quarter reading from the Conference Board Measure of CEO Confidence was reported at 65 and is the highest reading since the first quarter of 2011. Readings above 50 indicate more positive than negative responses.
Lynn Franco, Director of Economic Indicators at The Conference Board:
"CEO Confidence surged in the final quarter of 2016, reaching its highest level in nearly six years," said. "CEOs were considerably more optimistic about short term growth prospects in the U.S. than in the third quarter, and to a lesser degree about prospects in developed and emerging markets."
Empire Manufacturing report for January backed off of its recent highs, missing consensus forecasts in the process. While economists were forecasting the headline reading to come in at a level of 8.5, the actual reading came in at 6.5. The current conditions index backed off slightly; expectations for the future remained right at their multi-year highs from last month.
Philly Fed did not disappoint, as it increased from the 19.7 reading reported in December to 23.6. Analysts forecasts were calling for a reading of 15.3. A positive report overall, another clue that improvement trickles into the economic narrative.
Industrial Production ramped up in December, rising 0.8% versus the 0.6% expected by analysts. What the report is telling us is overall production is muddling along, and the recent strength is all due to the ongoing recovery in the energy patch.
Better than expected reports have outnumbered weaker than expected reports recently, but I have noticed that the margin is not nearly as wide as I saw a bit earlier. If past history repeats, we might see softness in the early part of the year, similar to the past 2 years. A positive sign that the latest period of economic strength may be gaining momentum, would be a lack of any across the board weakness in the first two to three months of 2017.
Homebuilder confidence pulled back and fell short of expectation to start the year. While economists were forecasting the NAHB homebuilder sentiment survey to come in at a level of 69 this month, the actual reading came in at 67.
Housing starts beat expectations with 1.22 million (annual rate, seasonally adjusted) reported versus 1.11 million expected and 1.09 last month. The report also showed new highs in single family permits. The state of the housing industry remains resilient.
Global PMIs finished 2016 on a positive note. Sentiment indicators hit multi year highs. As a result, leading indicators for the OECD, U.K., Japan, U.S., Canada, Europe, Spain, Germany, Italy, France, China, Brazil, S. Africa, Mexico and Russia are trending up, supportive of expectations for stronger growth in the new year.
While just about everyone citing the election results here in the U.S. for the new found optimism for a pro-growth agenda, these global reports are not the result of the Trump victory. In fact, all we heard before the election was how the rest of the world viewed Mr. Trump negatively. Further evidence that the global economic data was improving well before the U.S. election.
Theresa May outlined her plan for Brexit in a speech delivered this past week. As developments play out, how much angst this will cause among traders is anyone's guess. The timeline for all negotiations to be concluded is 2 years away.
German auto makers voice their concern about what Brexit could mean to their industry.
U.K. Retail Sales took a hit to end the year as the ramifications of their vote to leave the E.U. ripple across their economy.
China's GDP growth beat expectations as it ticked up ever so slightly to 6.8%. While everyone was watching the markets reaction to the inauguration, this report may have been responsible for the markets strength early on Friday, as fears of China's demise slowly fade away.
Each earnings season I compile a list of headlines that provides me with a general sense of how the story is unfolding.
For those who are following the earnings story closely, it should come as no surprise that the two sectors that I expect upward momentum from are Energy and Financials. Early reports indicate that the banks are on target for further growth in profits.
With crude oil having stabilized in the fourth quarter of 2016 and now trading in the low 50's, that represents quite a different picture. This time last year investors watched WTI dropped in the mid to upper 20's and energy earnings, or lack thereof, followed. With the price of WTI gaining about 100% in a year or so, we can expect to see a fairly large rebound, as the huge weight hung around the neck of S&P earnings has been lifted.
Technology has renewed momentum this year as the Nasdaq has traded at new highs in the first two weeks of this year. I believe much of that is coming from renewed optimism in the areas that have in the past provided growth, while being saddled with a no growth agenda. The stock market is forward looking, and the new found strength in share prices may be reflecting a surge in earnings to back that up.
FactSet Research reports:
"The forward 12-month P/E ratio for the S&P 500 is 16.9. This P/E ratio is based on Thursday's closing price (2263.69) and forward 12-month EPS estimate ($133.84)."
The Political Scene
The "change" is official, President Trump is the 45th president of the United States.
We all know change has taken place, but the Financial Times tells just how much change the D.C circle will experience:
"Trump and his executive team have only 55 years of government experience but 83 years in business. Obama's comparable team had 117 years in government but only five years in business."
If the pendulum truly swings the way it appears, we should see the change the market expects down the road. Now, if we can only get a functioning Congress.
Following up on the opening quote on common sense, what I have seen regarding the cabinet confirmation hearings, the common sense being displayed at times by Congress can only be described as severely lacking.
The Fed and Interest Rates
Notable excerpts from the Fed's Beige Book released on Wednesday:
"Labor markets were reported to be tight or tightening during the period. Employment growth ranged from slight to moderate and most Districts indicated that wages increased modestly."
"District reports cited widespread difficulties in finding workers for skilled positions; several also noted problems recruiting for less-skilled jobs."
That observation would seem to mesh with what we are witnessing in the low jobless claims numbers. The latest report came in at 234K, marking the third straight week that claims came in better than expected.
Despite the issues that employers are having recruiting workers, the Beige Book is definitely emphasizing both a more positive economic scene and stronger labor markets to start the year.
Janet Yellen spoke the same day, and suggested that for now the committee remains committed to the idea of about three hikes this year.
Concerns over the recent fall in the 10-year Treasury are in my view overdone. Rates have dropped from a high of 2.60%, last December 15th, to a low of 2.3% this past Wednesday.
While declining real yields may seem to signal economic bearishness from the bond market, it is simply reversion to the mean that is once again signaling modest growth prospects. Yes, we have seen an uptick in the global economic data. In reality, though, the pro growth cocktail is just being mixed. We won't see a rip roaring jump to 4% GDP growth overnight.
While new found optimism has crept into the investment scene, fund managers are still well below the typical equity allocation. What they are recommending now is well below the norm.
Source: Richard Bernstein Advisors
In the latest survey from AAII, bullish sentiment dropped from 43.6% down to 37%. That 6+% decline is the largest weekly drop in bullish sentiment since March. Building sentiment to a frothy, over exuberant level is a process. It does not happen overnight. For those that were calling the recent spike of positive sentiment a sign of wild euphoria might want to go back to the drawing board.
This graphic depicts the importance of the $52 breakout level I have often referred to in the last month.
The banter this week centered around the Saudi oil minister commenting that he did not see the need to extend the recent oil production cuts. Crude oil traded above and below the breakout level during the past week. By week's end, WTI closed at $52.33, down $0.16 for the week. The close above the $52 breakout level remains a positive for the bullish chart watchers.
The Technical Picture
Jonathan Krinsky, MGM partners, gives his views on the technical setup as we start off 2017.
This past week the S&P recorded the first close below the 20-day moving average since December 30th. Just as we saw in December, the S&P rebounded the very next day to retake that trend line. While momentum has waned on many stocks and sectors, I do not find evidence under the surface that stocks are breaking down.
The chart below is somewhat "busy", please bear with me.
Chart courtesy of FreeStockCharts.com
The argument that has surfaced is the market has come too far too fast. Let's review. Further examination shows the twelve-month pattern for the S&P depicted earlier is strong, measured and consistent. The first leg up off the lows in February 2016 was a gain of 290 S&P points. A period of consolidation with a maximum drawdown of 4.8% to the Brexit low. The second leg higher equaled 193 S&P points, followed by consolidation and a pullback of 4.7% down to the pre-election low. Both consolidation periods were approximately two months in duration.
Since November the S&P is up 186 points, and it sure appears we are in a consolidation phase, which is about six weeks in the making. To date, this latest rally has mirrored the prior leg up. If the pattern continues to unfold as it has done in the past, the first step would be further consolidation in time, maybe another month or less, and the possibility for a 3-5% pullback. That yields a low of 2,170, just below the breakout level of 2,193. It would then be very similar to what happened in September 2016 when the S&P tested and temporarily broke below the first breakout level of 2,131.
This isn't exact science, so an investor/forecaster has to think in terms of probabilities. From what is revealed in the technical picture, I come to a high probability conclusion that the S&P has more consolidation ahead with limited downside. When I factor in the tight trading range we have seen, past incidents of that behavior have led to declines in the 3-5% range.
Since I believe that is the worst case scenario, my strategy will be to use any pullback of that magnitude to selectively add stocks for the next leg higher. If my thoughts prove accurate, active investors that act on pullbacks at the sector or stock level are likely to outperform.
Keeping in mind what was discussed last week, waiting for that eventually has its issues as well. There is also a best case (Bullish) story that exists as a possibility, while warranting a lower probability.
The S&P consolidates, and makes a run higher. There are three issues that make this possible. The first, there is no election uncertainty which weighed on investors after the first S&P breakout last year. Secondly, the new found animal spirits applied to a pro growth outlook. Third, the majority are of the mindset to hit the sell button on the inauguration news. If the S&P doesn't blink, the majority starts to scratch their collective heads, blinks and concludes they had it wrong. These issues put that scenario on the table as well.
Bottom line, how an investor plays the very short term depends on their individual situation. The market will decide how things unfold, and while that is happening, it will be time to watch for other signals that may toss any of those conclusions aside. Keeping in mind that as I sit here today all of the short-term gyrations makes little difference to the long-term trend. This trend remains the wind at the backs of the bullish story, and that is what has to be kept in the forefront of an investor's mind. The daily/weekly fluctuations take an emotional toll on us. Keeping the long-term trend in focus nullifies that urge to do something we might regret later.
Short-term support drops back to S&P 2,254, then 2,232, with resistance at the 2,270 and 2,282 pivots.
Moral of the story, it's best to ignore the quips of these influential and powerful investors. When you hear one of them speak, remind yourself that they have an agenda and are more than likely talking their own book. That seemed to be the case this time around as well. It's obvious their comments and the subsequent results reflected their incorrect positioning.
Individual Stocks and Sectors
The Financials came to life after the election on renewed earnings growth, but in fact they were beating consensus earnings expectations for the last eight quarters. The recent outperformance shows the role of sentiment and how it can change on a dime. Fourth-quarter bank results were expected to be as strong if not stronger than what was posted in the prior quarter and so far they haven't disappointed. The underlying trend for the sector is lower than forecasted provision expenses and solid top line revenue boosting earnings for most banks.
Morgan Stanley (NYSE:MS) added to the positives on the financial scoreboard with their recent earnings results. Goldman Sachs (NYSE:GS) did the same, topping estimates on both the top and bottom line. Citigroup (NYSE:C) beat on revenues with an increase of 6% over the last report, but missed earnings forecasts despite recording a 25% increase for the quarter.
Bank stocks sold off on the first trading day this past week (-2.3%), and that should come as no surprise given their recent strength. Time to keep a close eye on support and entry levels. We are in a mode where no report will be good enough, and that is the way it usually is after a group has run like the banks have in the last 2 months.
SA author Ray Merola points out what a rising rate environment means to the large money center banks with his missive on Wells Fargo (NYSE:WFC). I also enjoyed his thoughts and ideas on the technology sector for 2017.
This past week I added a regional bank that just reported an impressive quarter, Wintrust Financial (NASDAQ:WTFC). A community bank headquartered in Rosemont, Illinois, a suburb of Chicago, operating roughly 150 banking offices. A modest pullback from the recent new high was my key to initiate a position, with the idea of scaling in over time.
For those who are still wondering what is happening in the brick and mortar retail sector, it's simple. Bespoke Investment group calls it death by Amazon (NASDAQ:AMZN), and here is a chart that brings that point home. The last 10 years are all about online sales and the growth of Amazon.
Yes, that is a 1,934% increase over that time period at the expense of all of the major retailers. Wal-Mart (NYSE:WMT) is the only franchise that has held its own against this onslaught. The sector is a difficult one to have interest in now, and normally that would attract my attention. However, the sea change that is taking place is a difficult one to step in front of. My commitment to retail this year is centered on Nike (NYSE:NKE). My Dow Dog for 2017.
The shares of Marathon Oil (NYSE:MRO) and Oasis Petroleum (NYSE:OAS), two names that I believe will outperform this year have come back to attractive levels from their recent highs. Both stocks sit at support near their respective breakout levels. I added to both this past week.
After a strong start to the year, equities took a bit of a breather in the last two weeks. Stocks rallied in anticipation of growth and earnings enhancing policy reform, now they are in a waiting mode for clarity as to what exactly the reforms will look like.
Ryan Detrick tells us that during the last month, the Dow has traded in its tightest range (1.4%) since 1,900. Yes 1,900. As we kick off the second half of the month, the seasonal pattern shows no bias towards either the bulls or the bears.
Urban Carmel points out the historical election cycle which indicates a period of market weakness from now into the middle of February.
Chart courtesy of: SeasonalCharts.com via
Perhaps that is what many gurus are basing their sell the inauguration strategies on. FBN Securities agrees:
"With both the earnings reporting season and the transfer of power in the White House having the potential to augment skittishness. When there is a change of political parties in Washington, the market historically has fallen back, forming a buyable low around mid-February."
We have gone through three consecutive down Januaries in 2014, 2015 and 2016, something we have experienced only twice since 1950. The market has ever seen that happen four years in a row.
Last week it was suggested not to get too wrapped up in all of the commentary surrounding the incoming President. While it is apparent that investors need to be forward looking to keep up with the market, doing so to the point of excluding all else could distract an investor just enough to miss what is taking place currently.
The stock market is a long-term instrument comprised of stocks that pay out their cash flows over decades. The Presidency, on the other hand, is an inherently short-term series of events that cannot be properly judged within the time frames we apply to it.
We have been bombarded by political narratives about what will take place this year or the next four years. These stories should be put in their proper context as they are used to sell a narrative. Sometimes these stories can create a conflict between your risk profile and the actual market environment.
All of this commentary can be appealing and even rational sounding. When one starts to making sweeping moves, they invariably result in a misalignment of an investor's risk profile in an attempt to align themselves with a narrative. Instead, it is better to stay grounded and remain within a proper asset allocation and risk profile that matches their circumstances. All of that becomes especially important if one has a long time horizon.
While we watch and wait to see how long this current consolidation period extends, opportunities are there given the sector to sector rotation we have seen. This is the time to add undervalued, and for those that need a little cash, subtract over extended stocks from their holdings.
Bottom line, don't get hypnotized by the drumbeat of very attractive and even rational sounding stories about short term events that could or could not happen. Change brings about anxiety, and I expect to see that demonstrated in the form of market volatility to some extent during the next few months, so it is crucial to use common sense while remaining vigilant.
My prior observations that we are leaving the interest rate driven bull market and embarking on an earnings driven bull market were formed well before we heard about the pro growth agenda of the new administration.
Despite the bombardment that we were in an earnings recession, there was a fact that was muted. Ex-energy, the earnings of the remainder of the S&P 500 companies did not recede. As mentioned earlier, energy is now a positive. While we don't know the extent, nor the timing of any impact the new found pro-growth agenda will put forth, the initial conversations indicate that it has the capability to add fuel to the fire that has already started.
It is always best to stay focused on what matters, corporate earnings and the price action of the market. As I make the long-term trend that is firmly in place the focal point to guide my decisions, my objective is to not allow any short term gyrations distract that strategy.
Please give that some thought as you assemble your strategy tailored to your individual needs as we go forward in 2017. Despite its age, this bull market isn't over just yet.
Best of Luck to All!
Disclosure: I am/we are long AMZN,C,GS,MRO,NKE,OAS,WTFC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The opinions rendered here, are just that – opinions – and along with positions can change at any time. As always I encourage readers to use common sense when it comes to managing any ideas that I decide to share with the community. Nowhere is it implied that any stock should be bought and put away until you die. Periodic reviews are mandatory to adjust to changes in the macro backdrop that will take place over time.