Weighing the Week Ahead: A Time of Tension
World tensions continue to mount. Economic data were soft, yet the market rallied. How can this be?
There are many skeptics of the most hated rally in history. Conspiracy theories abound. Anyone who is not a regular, loyal, and convinced reader has missed this rally. If they remained on board (judging from emails and calls) they bailed out at the wrong time last week.
Why have so many been so wrong for so long? How can the market rally in the face of so many worries?
My own answer is a simple one: Stocks are attractively priced relative to other assets. On a risk/reward basis the value is better than it was at the market bottom. The general pressure from the really big money is to the upside. In the last few months I published two articles showing this — one from a big-time private wealth fund manager and another from the most successful hedge fund manager.
Some newbie hedge fund types are in denial, looking for political or economic conspiracies to explain their poor analysis. This pop econ approach has grown like Facebook, but it does not mean that the information and analysis is reliable. Last week I demonstrated that the bond pundits were dangerous for investors. The list of misinformation and disinformation is so long that it is hard to fight. The widely cited Bill Gross commentary about funding the US debt did not even mention the daily trading ($550 billion) in Treasury securities. And this does not include the deep and liquid futures market. It is a big and self-serving scare, as I pointed out.
How does this relate to stocks?
Here is the explanation from Bill Miller of Legg Mason (same name as my dad, but no relation):
Regular readers of “A Dash” may remember that I offered the same analysis early last December. You could have made 7% in a few months from that article, pointing out that the risk/reward was better than the market bottom. The analysis is still correct. While the market has rallied, so have earnings.
Most observers foolishly focus on absolute prices instead of a dynamic system of earnings, interest rates, economic prospects, and risk.
The Bespoke Investment Group analyzed Bill Miller’s performance. Check out their chart.
Let’s turn to our regular weekly review, but I shall return to the investment prospects in my conclusion.
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
I wrote last week that the upcoming data were less important than world events. The economic news was rather poor overall, but let’s look at the full picture.
To keep perspective, we should note that most major economic indicators remain in positive territory. There is growing recognition that the economic rally now has a self-sustaining character.
- Initial jobless claims remained lower, at 382K, consistent with the gradual trend.
- Gallup‘s job creation poll looks better, but don’t get carried away. 83% still see this as a poor time to look for a quality job.
- Q410 GDP was revised upward and relied less on inventory building.
- Stocks showed a good tone, shrugging off the many worries.
The bad news centered on housing and Japan.
- Economic growth forecasts weakened. The ECRI Weekly Leading Index fell slightly, to 129.3. The growth index pulled back from the peak, 7.1% to 6.5%. These are still 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 +.155, a bit higher than last week’s +.006. I am putting this in the “bad” category since it has moved higher, but 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.
- Various other economic reports. Check out some sources that I follow every week. Steve Hansen has a detailed analysis of each release and other news as well. Even New Deal Democrat was downbeat on last week’s data.
NB: The ECRI and SLFSI are actually readings from week-old data.
- New Home Sales plunged to a seasonally adjusted annual rate of 250K. New homes cannot compete on the market against distressed properties.
- The OldProf’s NCAA Brackets. Gone, all gone. Worst year in a decade. Too many black swans.
The Continuing Uncertainty
I think I was on target with last week’s comment on this front:
There is a tension in US foreign policy as it relates to revolts against dictators. On the one hand, we applaud the outbreak of democracy around the world. On the other, we note that this movement has the potential to topple both friends and foes. While I have my own opinions about foreign policy, my mission at “A Dash” is to discern the investment implications.
I see an ad hoc policy, lacking a consistent guiding principle. How else can one explain intervention in Libya and a sideline stance in Bahrain?
The turmoil has created a premium in oil prices of $15/barrel or so. Depending upon events in the region, that premium might move either way, but the bias seems higher.
There was a little less uncertainty last week on the Japan front. The human toll is mounting; the economic cost is better defined. Some production is coming back online. Companies are finding alternatives to supply chain issues. We still will not know the full economic consequences for weeks or months.
The Middle East North Africa story continues, with a new threat mentioned each week.
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:
- Only 29% of our 56 ETF’s have a positive rating, down from 45% last week, a continuing trend.
- 95% of our 56 sectors are in our “penalty box,” up from 86% last week. This is an indication of very high short-term risk.
- Our universe has a median strength of -23, down from -11 last week, also a negative trend.
The overall picture continued to deteriorate last week. We reduced positions in trading accounts to 20%, holding only the single strongest sector.
[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
Events around the world will have continuing major significance.
On the data front, it is employment week. We’ll get Challenger layoff data at mid-week. Did you know that more people quit their jobs than are laid off? Did you know that the economy creates over 2 million new jobs every month? If not, maybe you missed my piece on employment data.
Non-farm payrolls and unemployment will come out Friday. I usually do a preview on Wednesday, but one of my three inputs is the ISM manufacturing index. Sometimes I estimate from the Chicago Index, but even that is not out until Thursday. I will be attending the Kauffman Economic Bloggers Conference, so I might not post on Thursday or Friday.
I’ll merely say that I am still not excited about net jobs gain for this week, although I expect to see a major rebound in the months ahead.
On the political front we have a continuing issue about a government shutdown. I have been following this closely –both the polls and the political maneuvering. 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.
My current market viewpoint is sharply divided, depending upon the time frame.
In short-term timing I look both to my own models and also to the weekly chart show from Charles Kirk. The modest membership fee (which either defrays costs or is donated to charity) entitles you to the chart show, a wonderful organized linkfest, and access to various stock screening approaches. This week Charles discusses his current bearish stance and, as always, precisely what it would take to change his view. If only everyone did the same!
While we are not short, we are under-invested in trading accounts, and not enthusiastic about next week’s data.
In long-term timing I adhere strictly to the fundamentals of year-ahead forward earnings, interest rates, economic growth prospects, and measurable risk. Concerning that last element of measurable risk, I don’t mean laundry lists of worries that everyone knows about. If there is risk, it shows up in some market metrics, especially credit markets. That is why I follow the SLFSI.
I understand that many others seem to believe that the market has been rising strictly due to Fed intervention. I disagree with this conclusion, so it is on my agenda for further discussion. Meanwhile, I respect and recommend alternative viewpoints, so listen to what Charles Kirk (recently returned from complete immersion with hedge fund types) has to say as well.