Weighing the Week Ahead: A Bigger Wall Now Under Construction
The economic calendar is important this week featuring data on personal income and spending and the Fed’s favorite inflation measure, the PCE index. Housing data includes four reports, with new home sales of special interest. There are also reports on consumer sentiment from both the Conference Board and the University of Michigan.
Most of the economic reports have been beating expectations, but investor concerns seem to have increased. The Wall of Worry has some new bricks provided daily by the flow of news. This raises the question:
How should investors respond to the many headline risks?
[Mrs. OldProf warns me that some readers might have a different wall in mind when they see today’s title. I say that I’m allowed to have fun when I write, and real investors will get the message].
Last Week Recap
In last week’s installment of WTWA, I asked whether falling confidence was a threat to markets. This was indeed a topic for some, but not as prevalent as I expected. There was a little of attention to the lag in business investment, but not much “connecting the dots.” For most financial sources it was all Fed, all the time.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring the Investing.com version. It is static in this report, but if you go to the site you can use a number of interactive features. For those who want to explore the effect of specific events, there are news callouts.
The market lost 0.5% for the week with a trading range of just 1.4%. The move during Fed Chairman Powell’s press conference looks big, but really was not when placed in the week’s range. You can monitor volatility, implied volatility, and historical comparisons in the Indicator Snapshot below.
Personal Note – Moving Time Has Arrived
We are moving to our new home next weekend. Mrs. OldProf and I very much appreciate the many suggestions from readers. We did a lot of online research and also checked out many places in person. Our decision was right for us but based on some specific needs and requirements.
I will probably not publish WTWA next weekend, but I might do an “Indicator Version.” In two weeks, I’ll be writing from a new location – much different from my current one in both climate and political leanings.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
New Deal Democrat’s high frequency indicators are an important part of our regular research. The results remain positive in all three of the time frames. The long leading indicators are very positive with only the yield curve is negative territory. NDD is watching for the effect on profits, and we should all join him.
- Industrial production for August increased 0.6% versus expectations of only 0.1% and the July loss of 0.1%.
- NAHB Housing Index for September improved to 68 beating August’s 67 and expectations of 66.
- Housing starts for August were 1364K (SAAR). This was much better than expectations of 1255K and July’s (upwardly revised) 1215K. Calculated Risk comments on the data, pointing out the strong year-over-year comparisons. Bill’s long-standing prediction of a “wide bottom” in housing, missed by most others, has been playing out. He “now expects some further increases in single family starts and completions.”
- Building permits for August mirrored the strength in housing starts, at 1419K (SAAR). Expectations were 1300K and July was 1317K.
- Homeowner negative equity decreased in Q219. (CoreLogic via GEI)
- The Fed cut rates by 25bps as most expected. The initial market reaction was disappointment. This was quickly retraced as Fed Chairman Powell made some reassuring comments during his press conference. And perhaps, as subtle message to Trump on the trade fight. (WSJ). Tim Duy has the expected excellent summary. He cites and critiques various opinions, discusses Fed communications, and the questionable need for consensus. He also discusses the Repo issue (see today’s worries section).
- The government is unlikely to shut down after the House voted for a deal. This gives us another two months or so.
- Existing home sales for August registered 5.49M (SAAR) versus expectations of 5.36M and July’s 5.42M.
- Rail traffic weakened again reports Steven Hansen (GEI). He recommends a year-over-year comparison of the 4-week rolling average of the economically intuitive sectors (taking out coal grain and petroleum). This approach smooths a noisy series and avoids the need for a seasonal adjustment. Read the full post for more data, analysis, and charts.
- Mortgage applications declined by 0.1% versus last week’s gain of 2.0%.
- Leading indicators for August were unchanged versus expectations of a 0.1% gain. July was downwardly revised from a gain of 0.5% to 0.4%.
- Architectural billings declined markedly in August. July was already soft. (Calculated Risk).
Your TV is watching you. Geoffrey A. Fowler (Washington Post) analyzes the hidden side of your smart TV. Data about what you watch is collected and sold to those wanting to sell you something. It does not matter what source of programming you are using. The article explains that you probably gave your permission for this during setup and how to change that.
Some of us are also monitored by Alexa, but I’ll leave that for another day.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
The calendar is bigger than usual, including key reports on personal income and expenses, housing, inflation, and consumer confidence. Competing for the financial headlines will be breaking news about worldwide problems and the continuing Washington soap opera.
I am counting the days until earnings season!
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The economic data have been generally stronger than expected. Dr. Ed Yardeni has a helpful analysis of the Citigroup Economic Surprise Index, which compares results to expectations.
Those of the bullish persuasion wonder why this has not led to a stronger stock market.
Bears ask how markets can hover near all-time highs in the face of the dangerous “fundamentals.” These include a wide range of topics, but feature economic collapse, incipient conflict, and the presence of dangerous “bubbles.”
At the heart of this controversy is how the market deals with pending issues. Let’s call them “worries.” One of the most important and least understood investment concepts is the “wall of worry.” Many see it as just a list of reasons to be frightened, but it is quite the opposite. One of my favorite posts of all time is Jim Abbott and the Wall of Worry. If you are not familiar with Abbott, a star baseball pitcher missing the fingers on one hand, you will find the story inspirational. I then recounted some of the obvious problems of the day, contrasting market action with the skepticism of the day. The concept is so important that it provided the foundation for my 2010 Dow 20K prediction.
It is difficult, unpopular, and profitable to have a bullish market viewpoint when the general news flow is so negative…
…How can stocks rally with so much to worry about? To answer this question you need to consider what these lists would have been like a month ago. Some of the worries have been crossed off! Others have been reduced.
- The crash of the Euro, the sovereign debt crisis, and the “cockroach theory” have not come to pass.
- Corporate earnings have remained strong — both current and prospective — despite skepticism.
- None of the extreme “technical” forecasts — Hindenburg Omen, head-and-shoulders top, Death Cross, or Dow Theory signals came to pass. Some are now reversing.
If you watch the lists of worries as they change over time, you can see that some important concerns drop off. This climbing of the “wall of worry” best explains both the current market action, and also the week ahead.
And here we are again. The headline news provides a steady stream of bricks for the current wall of worry. This leaves the following question:
How should investors respond to the many headline risks?
How you respond to worrisome news is one of your most important investment decisions. I am going to list some of the current worries, the possible implications, and my take on what action is implied. I have also included links to some key stories.
|Problem||Implications||What to do|
|Inverted yield curve||Early recession indicator||Watch for confirmation. Reduce positions if you get it. This is not a “light switch” indicator.|
|Low long-term bond yields||Usually associated with low inflation expectations and weak growth. Bottom in? (Gundlach)||This is partly “imported from Europe” where many bonds have negative yields. Assets flow to the US where even the modest yield looks good. Watch inflation signs carefully along with independent growth indicators.|
|Companies (like FedEx) describe earnings impact from trade issues. Also truckers.||This is interpreted as the need for fund managers to expect a long trade war.||Use your own analysis of top sources. Companies can tell you about their current business. They can explain their concerns about the future. They cannot predict the outcome of the trade war any better than you.|
|Attacks on Saudi oil infrastructure||Higher oil prices. Threat of outright war.||Exposure of new vulnerability implies a likely risk premium for oil prices. This affects the entire oil complex, but in different ways. Understanding this can help your investments. (Barron’s)|
|Brexit||Economic pressures, especially in the Europe and UK.||Nothing specific, unless and until it becomes time to increase allocations to European stocks.|
|North Korea||A possible nuclear exchange.||Classic example of a serious problem where there is no effective investor hedge.|
|Trade war||Lower global growth, spreading beyond the immediate tariff targets.||Monitor the impact on recession odds. Adjust allocations in sectors directly affected.|
|Leadership concerns||Many investors fear a policy mistake.||Generalized concern is a poor reason to alter investments. Situations where action is called for are rare and fairly obvious.|
|Uncertainty and volatility||Often responsible for short-term market moves and interpreted as fear.||These are not effective leading indicators. Investors who know how to value individual stocks and sectors can exploit these fears.|
Blair Duquesnay takes note of investor fear and describes some of the reasons, starting with the “tone of every 24-hour news channel must be extremely negative these days.”
I welcome more “worry” suggestions in the comments. I’ll have some additional observations in today’s Final Thought.
Quant Corner and Risk Analysis
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.
Short-term technicals have been stable in the neutral range. Long-term technicals have also stabilized at neutral. Recession risk is still in the “watchful” area. We are seeing little confirmation for the risk signals, which we have been monitoring since May.
Considering all factors, my overall outlook for investors remains bullish.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score”.
RecessionAlert: Strong quantitative indicators for both economic and market analysis
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
Prof. Menzie Chinn reaches the interesting conclusion that the climate of uncertainty from the President’s tweets has strengthened the dollar. This is, of course, the opposite of his stated objective.
James Picerno presents his regular economic update. He sees continuing slow growth, some recent improvement, but some indicators suggesting more risk. “Recession risk, in short, could rise from currently low levels.”
And from the Daily Shot, this chart of one of our key indicators, with some adjustments for inflation.
And the pressure for higher long-term rates (which would increase yield-curve slope).
Insight for Traders
Our weekly “Stock Exchange” series is written for traders. I try to separate this from the regular investor advice in WTWA. There is often something interesting for investors, but keep in mind that the trades described are certainly not suitable for everyone.
This week’s edition discusses a crucial topic for both traders and investors—having and following a risk budget. As always, we share some picks including ideas from our new member, Emerald Bay. Pulling it all together and providing counterpoint drawn from fundamental analysis is our regular series editor, Blue Harbinger.
Insight for Investors
Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.
Best of the Week
If I had to recommend a single, must-read article for this week, it would be Nick Maggiulli’s The Cost of Waiting. He analyzes a common question about lump-sum investing – get in immediately or dollar-cost-average? There are a number of reasons to space out new investments, but projected return is not one of them. While he has done calculations on various asset allocations, this post looks at a more conservative 60/40 portfolio. There is plenty of background and some good links, but here is the key conclusion:
My results show that any stock/bond portfolio combination (even a 100% bond portfolio!) would have, on average, outperformed a 24-month DCA into an all-stock portfolio. If that statement doesn’t shock you, let me make it more concrete.
Let’s say you had $2.4M you wanted to invest in the S&P 500, but you were too shy about going all-in now. So, you decide to invest $100,000 a month for the next 24 months. My analysis shows that you would have been better off had you invested all $2.4M into any stock/bond portfolio combination (80/20 stock/bond, 20/80 stock/bond, etc.) at the beginning instead of averaging-in over time.
Here is just one of the informative charts.
Check out the full post to see other comparisons.
Chuck Carnevale cites AGNC Investment Corp. (AGNC) as another example of a REIT that is not suitable for retirement accounts.
Arturo Neto suggests REITs Are Solid Investments, But They’re Looking Pricey.
Post-spinoff ideas can be quite good. Wedbush sees “big upside” in Nuance Communications (NUAN) after it spins off its auto business on October 1st. (24/7 Wall St.)
Turnaround in Triple-S Management (GTS)? David Merkel (blogging again!) lays out the reasons.
The Delivering Alpha Conference always includes opinions from big names in the investing world. Stocks often move during a presentation as attendees call in orders. ValueWalk has an interesting collection of the presentations. The statements are often controversial and a good source of stimulation.
Abnormal Returns is the go-to source for anyone serious about the investment business. The Wednesday edition has a special focus on personal finance, with plenty of ideas for the individual investor. As always there are many good links. Given what I am calling semi-retirement (reduced managerial role but continuing stock and market analysis, portfolio management, and writing) I have a special interest in this topic. There is a section including several great articles.
One is by Christine Benz (Morningstar) who analyzes the importance of a solid portfolio review in advance. [Since this is what I do with my clients, I heartily endorse this point]. A key element neglected by many is how to keep up with inflation. And of course, the bill for healthcare since “the average 65-year-old-couple will spend $285,000” during their retirement years.
Ivan De Luce reports on a psychological study finding that the happiest retirees has “built themselves new lives.” This means different things for different people, of course, but treating “every day as Saturday” is not an option.
Watch out for…
High dividend-yield stocks.
And low volatility stocks, trading at a big premium to the market.
I sometimes forget the need for an occasional review of the wall of worry concept, although I mention it each week. Investors should embrace well-known and well-documented worries. These are already reflected in market prices. It is the total surprises, the black swans, that are more worrisome. There is always a long list of worries. The current list is not better or worse, it is just different. We have forgotten the worries from years ago and next year we’ll have a fresh batch that we cannot imagine right now.
- Most worries do not provide a basis for overall market action. Trying to time the market using headlines is a road to ruin. Some worries provide opportunities or warnings about specific stocks or sectors. This requires doing your homework to find the right themes. Then you must be contrarian, acting when others are fearful.
- Election season will lengthen the list of perceived worries. Candidates thrive on offering solutions to existing problems, and often negative campaigns. Duke’s Fuqua School does a quarterly survey of CFOs. This group’s optimism level is at a three-year low with a majority expecting a recession before the election. [I am suspicious of their recession forecasting prowess, but it is evidence about influences on business investment].
- Just because asset prices rise “does not mean that every risk is about to pop,” writes Joe Weisenthal. Why We Love to Call Everything a Bubble.
The opportunities are more difficult to see. Dr. Brett Steenbarger is an expert at finding opportunity and helping others to do the same. In Are We About To See Opportunity In The Stock Market? he contrasts the negative sentiment with recent stock strength. His explanation pulls together technical indicators from a variety of sources. Here is one of several examples:
The TraderLion site observes that powerful moves in individual stocks–gains of 20+% in one to three weeks following an upside breakout–tend to continue over a subsequent eight weeks, as the momentum attracts investors seeking rapid gains. In my own research, I track the number of stocks across all U.S. exchanges that make fresh one-month new highs. (Data from the Barchart.com site). When that number has exceeded 1200 since 2010 (N = 141), the Standard and Poor’s 500 Index has been higher 120 times and lower 21 times fifty days later, for an average gain of +3.83% (versus +2.69% for the rest of the sample). In such cases, market strength does not suggest an “overbought” condition ripe for reversal. Rather, the breadth and strength of the move tends to lead to further gains.
And he concludes:
To be sure, events in global trade, oil supply, and myriad other factors could tip markets and the economy. Evidence is growing, however, that stocks are not only strong, but showing the kind of upside breadth that has led to intermediate-term upside. In the wake of recession and trade fears, a year-end rally could spark quite a chase among money managers eager to lock in 2019 performance.
The Great Rotation Continues
As money leaves the crowded trades, specific stocks and sectors are the beneficiaries. The recent rally is just the start.
Headline news commands your attention but obscures the best market opportunities.
The successful investor learns to climb the wall of worry.
[If your portfolio is loaded with crowded trades, it might be time for a change. Write for my free sector spotlight paper on housing, currently my favorite sector. You will get some ideas about replacing over-valued stocks with those showing great potential. While I will be busy packing this week, you can still get one of the remaining spots for a portfolio consultation – complimentary and without obligation. Just send an email request to info at inclineia dot com].
Some other items on my radar
I’m more worried about:
- Iran confrontations and the chance for an accidental war.
I’m less worried about
- Technical market reactions. Another week of market action has improved technical conditions potentially swinging some active traders to be more bullish.
- Fed repo operations. These were technical operations in unusual circumstances, not a precursor of another 2008 crisis. Cullen Roche has a good explanation and Bespoke has some informative charts.