Weighing the Week Ahead: Approaching Dangerous Curves?

Crunch time!

Our decisions are always important, but this week could be special. I am giving it extra attention and extra work.  I recommend that others do the same.  It is not enough to passively watch the news.  It means preparing for events!  If you do not already have a solid position, you should be poised to react.

For several weeks there has been a sense of an impending inflection point.  It is apparent in the technical analysis, with many indicators at key levels.  It is obvious in sentiment.  And it is obvious in the fundamental issues — most significantly the fiscal cliff.

The political season has created deferred decisions.  This has caused business leaders to defer risk.  The cautious outlook from nearly every company reflects these concerns.  Why not?  Any executive who did not give some lip service to the litany of worries would seem pretty stupid.

Should we take this information at face value?

I'll offer my own take on these complex themes in
the conclusion, but first let us do our regular review of last week's

Background on "Weighing the Week Ahead"

are many good lists of upcoming events.  One source I
especially like is the weekly post from the WSJ's Market Beat blog
There is a nice combination of data, speeches, and earnings reports.

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

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
  2. It is better than expectations.

The Good

The economic news last week was mostly positive.  Perhaps it is partly the political season, but there was a little bit of "yes, but" connected to each report.

  • Earnings.  The earnings "beat rate" is improving as the season progresses.  This is an improvement over the recent pattern, and on a pace to better than last three quarters.  (But we know expectations were lowered).  Bespoke has the story and a great chart.


  • The Chinese economy, as measured by the "official PMI" is improving.  Kate Mackenzie at FT Alphaville explains that it is really a mixed picture.
  • Consumer confidence from the Conference Board is stronger.  At face value, this means a reflection of better current conditions and employment.   Doug Short has the "yes, but" in his thoughtful post and great chart.


  • Payroll employment grew significantly.  The "yes, but" is that the overall rate of growth is still disappointing.  Calculated Risk has a measured and thoughtful assessment, with plenty of charts.  Derek Thompson suggests that the report is better than the headline, since the revisions imply a gain of 255,000 net jobs gained.  The pace of gains in the last three months is much better, as you can see from his chart:

Screen Shot 2012-11-02 at 9.24.55 AM-thumb-615x454-104018

  • ISM manufacturing was in growth mode and better than expected.  It is consistent with economic growth of 3.1% based on ISM research.  Steven Hansen at GEI has a thoughtful look at the index and the various components — well worth reading.

The Bad

The actual data last week was pretty good, but the stock result was
bad.  This happens, and it can be meaningful.  Let us take a closer



  • The European economy weakens further, as measured by the PMI reports (via FT Alphaville).
  • Employment disappointments included no improvement in hours worked (which trades off freely with new jobs at a rate of 330K jobs per hour or so), in hourly wages, or in long-term unemployment.  These are all significant elements of the complex employment story.
  • Light vehicle sales, while up from last year were down from last month.  (Via Calculated Risk).
  • Sandy costs.  These are now in the $50B range and mounting.  Various pundits are speculating (in both directions) about the impact on GDP and economic growth.  It is far too soon for this kind of discussion.  It is a negative on all fronts.

The Ugly

The US electoral process.  It has worked for centuries, but it seems to be broken.  The campaigns are now paying  about $1000 per head to reach the undecided voters in a few states.  The voters sought are the least educated and least informed.  They claim to hate negative advertising.  In actuality, research shows that the negative ads swing them.  If you are a voter in my state (Illinois), your presidential vote does not matter.  Will this discourage people from participating?  Other races are still important.

The Indicator Snapshot

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

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. 
Bob and I met this week, planning an update soon after the election. 
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.

RecessionAlert uses a variety of different methods, including the ECRI, in developing a Super Index.  They also offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now over a year old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting.  The most recent news from the ECRI states
that they are "Assessing the Current Optimism."  This is apparently available only to paid subscribers, the ones who had early access to the 2011 forecast.

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

Indicator snapshot 110312

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 shifted to a bearish position, but
it was a pretty close call.
These are one-month forecasts for the poll,
but Felix has a
three-week horizon.  Felix's ratings have continued to drift lower. 
The penalty box percentage measures our confidence in the forecast. 
That indicator has moved to the top of the range, indicating little
confidence in the current bearish rating.  It has been a close call over
the last few weeks.

[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

This week brings very little economic data.

The "A List" includes the following:

  • The election (T).  For investors, it is not merely about the Presidential election, but the shape of Congress.
  • Initial jobless claims (Th).  Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

The "B" List" includes these entries:

  • Michigan Sentiment (F).  A good read on employment and current conditions.
  • ISM services index (M).  The service sector has become more important than manufacturing.  This series does not have the long history of the ISM, but is gaining more attention.
  • Trade balance (Th).  Important for the GDP and overall economic health.

There will also be many more earnings reports from a wider
variety of sectors.  We will probably also see (after a refreshing interlude) some Europe stories.

Nothing will match the election analysis, with investor implications for the fiscal cliff, taxes, economic growth, and specific stocks.

Trading Time Frame

Felix has shifted to a bearish posture. It has
been a close call for several weeks, but it is now turning more
negative.  Felix
has done very well this year, becoming
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 again this
week.  We are 1/3 invested in an inverse ETF for trading accounts, and another 1/3 would not be surprising.

Investor Time Frame

Each week I think about the market from the perspective of different
participants.  The right move often depends upon your time frame and
risk tolerance.  Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Investors often let the calendar tell them when to review.  I recommend taking a look this week.  Here is what to think about:

  1. Risk.  If you are like the average investor you have it all wrong.  You have been piling into bonds, gold, and dividend funds.   All of these categories are now over-valued, the result of this stampede.  Barron's featured the dividend funds on the cover.  Josh Brown had an instant reaction, saving me the job of saying the same thing (although my piece would have been less colorful, more pedantic, and less fun).  Read what Josh says!
  2. A portfolio anchor.  You need stability.  If you are trying to do it with bond funds, you need to understand the risks.  I prefer owning specific bonds.  I have had some excellent comments and emails on this theme, and I am working on a joint post that will further clarify.
  3. Stretching yield.  My approach is to find some reasonable dividend stocks and sell near-term calls against the positions.  If you did this skillfully, you could hit double-digit annual returns with significantly less risk than simply owning dividend stocks.
  4. A little octane.  Many investors do not think carefully about asset allocation.  There is always volatility, so the key is to "right-size" your position.  Instead of trying to time the market, try to be a player in the right sectors, the right stocks, and the right size.

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.  I am trying to be helpful and I love feedback.  We
have a good discussion going on bonds versus funds, and I plan a
separate article that will provide a further forum.)

Final Thoughts on Dangerous Curves

I am following four themes:

  • Mistakes about the Fed.  Regular readers know my feelings
    about trying to explain every twist and turn of the market.  The
    financial media are hungry for content, and pundits are happy to
    oblige.  Usually it is best to ignore.

Friday was a bit different.  Stock futures got a boost from the
pre-market release of the employment report.  The selling during the day
took the market to the lows, a swing of 200 points or so in the DJIA. 
Some writers were revising their stories, trying to find something wrong
with the employment report — a real stretch given the size of the
move.  Some attributed the selling to continuing coverage of Sandy, with
damage estimates rising — perhaps.

Other reports of trader thinking suggested that the employment news
might mean a change to Fed policy and QE3.  (Steven Russolillo covers the story
for MarketBeat and Bob Pisani had a similar report on CNBC).  I am not
questioning these reports, but the reasoning of those cited is dubious
at best.

The most important aspect of the QE3 announcement is that the Fed is
not going to change policy because of a data point or two, or three or
maybe even five.  They have embraced a different policy approach,
looking for solid indication that the deflation threat has been
addressed.  There is more willingness to tolerate some inflation to
reach that goal.  It is an important lesson which those fighting the Fed
will eventually learn.  For starters, readers should look at the public
statements of Fed members from the last week:  Fed’s Kocherlakota: Fed May Not Be Providing Enough Stimulus, Fed’s Rosengren: Fed Should Buy Bonds Until Unemployment Hits 7.25%, Fed’s Williams: New Stimulus Is Having Its ‘Desired Effects’.

  • The fiscal cliff.  This is the big wild card for the economy.  My working assumption is that the pieces are in place for a compromise, perhaps launched with a delay, under any election scenario.  I have considered each, finding a core of supporters.  While I prefer to elaborate after we have the results, it is the key economic issue.  Failure to deal with this problem is the single biggest challenge to our non-recession forecast.
  • The pause in business investment.  Decisions have been deferred and cash is piling up.  This has not been an economic disaster because the consumer has stepped up.  If businesses get more certainty from the election (even if not the rules they want) I expect a change.
  • The upside risk.  Most investors do not even worry about missing the upside.  They are in all of the wrong places and will start worrying when it is too late.  Investors will get a statement or two that shows losses in their bond funds at the same time stocks are rallying.  After that plays out for a few months, we can start to worry about a market top.

And finally, the biggest worry — a no-decision in the election.  I understand that there are confident pundits predicting victory in both directions.  Let us suppose that a key state — Ohio or Florida — does not have a decisive outcome on election day.  Let us further suppose that this result swings the election.  I can even imagine outcomes where the election would be determined not by the Electoral College tabulation, but in the House of Representatives.

As I noted last week, the market hates uncertainty, so this would be the worst case.


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  • Mike Niemeyer November 4, 2012  

    You wrote that the average investor is all wrong, piling into gold. Do you have something to back this up? For example, if the big money only had 20% ownership of GLD trust that would be a signal. Or something on the futures market…
    Always enjoy reading your work.
    Thanks Jeff

  • oldprof November 4, 2012  

    Mike — As I always note in the weekly article it is a place for me to share conclusions. The scope is such that I cannot do a lot of depth on each point.
    With that in mind, I did not single out gold, but cited it as a pattern of behavior where investors seem to think that stocks are very risky and these other assets are safe. The recent performance is itself proof of this, since it shows where the money is flowing.
    I suppose that I am overdue for an article on gold. The basic theme is that it works well when there is great fear of financial collapse or hyperinflation, what I have called the “golden goal posts.” Since I see both risks as minimal, I think the fears are over-stated.
    I also talk with investors who have huge allocations to gold. What would you think the normal range should be?

  • Mike Niemeyer November 4, 2012  

    My portfolios are about 2% in DBP and 1% in GDX. The max allocations: 4.5% in DBP and 2.2% in GDX.
    I searched a bit to look for your thoughts on gold and look forward to any update you might do on this subject.
    Thanks for briefly sharing your thoughts,

  • oldprof November 4, 2012  

    Mike — Your positions are very reasonable. A 5 -10% allocation, depending upon individual circumstances, can make sense. You might be surprised to learn that many have allocations of 30-50% or even more. I see it nearly every week.
    Here is an article I did a couple of years ago. I don’t think much has changed. I am certainly not trying to do market timing in gold, and I question those who think they can.

  • Mike Niemeyer November 4, 2012  

    If someone has 40% in gold they must be buying into (hook-line-n-sinker) the idea that gold is money and trying to ignore price fluctuations.
    I like the following explanation from James Grant; it would be interesting to see what gold would do if he became the Fed chairman (a low probability event),
    James Grant:
    It is the nature of gold that its valuation must forever be a mystery. It earns nothing. It pays no dividend. No conference call, no management to call up and complain to. What I do think is gold is simply the reciprocal of the world’s faith in the institution of managed currencies. It is one divided by T, where T stands for trust. And trust is a shrinking number and will continue to shrink. Therefore, I am still bullish on gold.
    Thank Jeff

  • Mike Niemeyer November 4, 2012  

    and just found
    Golden Haarp & Allocated Gold Exposure
    Jim Willie CB
    I would guess that you figure Jim as a crackpot! I’m inclined to greatly discount what he says. Like Max Keiser, some entertainment value at the very least.

  • Bruno V. November 6, 2012  

    I enjoy reading your blog as it often challenges my bearish views of the market. I tend to put weight on good research on market valuations such as Shiller’s P/E, Q-Ratio, dividend yield, historical earnings growth, overall financial leverage in the economy, etc.
    I have just read your “Tips for Investors” page where you refer to your 17 April 2012 post “Confused about Stocks”, linked to Dick Green’s blog at Briefing.com talking about “The Bearish Arguments That Are Wrong”, in particular arguments on “the 10-year Shiller P/E shows stocks overvalued”. Dick says that the Shiller P/E is biased due to the drop in earnings in recent the financial crisis, and thus not valid to the current situation. I see something different from another view below.
    Can you shed light on the recent AQR letter by Cliff Asness recently cited by the Economist? Citation and link below:
    Mr Asness points out that there is a danger of small-sample bias and that the standard deviation of results is quite high. Nor is the Shiller p/e much use as a market timing signal; it was already high in the late 1990s and got even higher by the spring of 2000.
    Shiller sceptics argue that the ratio is a particularly misleading indicator at the moment because of the steep plunge in earnings in 2008; this, they say, artificially depresses the 10 year earnings average. But the big fall in earnings in 2008 came in the finance sector which had enjoyed an artificial boom in previous years. Mr Asness suggests that the earnings destruction post-2008 was making up for some earnings that, for several years prior, were “too high”, essentially borrowing from the future. Rather than invalidate the Shiller method, the 2008 earnings destruction is precisely why the (Shiller p/e) was created.
    In any case, Mr Asness calculates cyclically-adjusted p/es based on the median earnings level of the previous 10 years, to eliminate outliers; and a version based on the maximum earnings over the past 10 years. In both cases, the p/e is significantly above the historical average. That is a big contrast with the one-year p/e which most investment bank analysts use and which shows the market fairly valued.
    What this means, according to Mr Asness, is that future real returns are likely to be poor, especially as bond yields are so low. On a standard 60/40 equity/bond institutional portfolio, real returns are likely to be 3%.
    Let me know what you think.

  • stock@hawaii.rr.com November 7, 2012  

    This Wall Street Journal site is awesome.
    Strongholds of the Republicans
    Areas that actually “work” and produce, are massively Romney. They in fact “are building that”.
    Strongholds of the Dems
    Old school areas on large bodies of water. They are still living on past glory, looking for modern day handouts on the shoulders of our grandchildren.
    Hard hit areas from oil spills, hurricanes, are quite a bit Dem, looking for handouts. Looking for Big Bro to save them.
    Areas with lots of immigrants.
    Pretty simple really.
    The black outline ones here are the counties that Obama won, very few geographically, but high density for electoral votes. The blue shaded area have become “more democratic voting” since 2008
    Below are the counties that Romney won, sheesh, anyone looking at this would say why is he not the president!
    Don’t hate me until you check out the charts
    http://oahutrading.blogspot.com/2012/11/counties-won-by-dem-rep. html

  • oldprof November 7, 2012  

    Bruno – I am working on a longer article on this subject, which I have taken up before. I will definitely get back to it.
    I have read the past Asness papers on this topic, and I’ll look at this one as well. Taking on a controversial and challenging topic in the comments is just not very efficient, but I will put it on the agenda.
    Meanwhile, if you use the search box on my blog and enter Shiller, you will find plenty of information. Especially note that even Shiller does not really recommend his own method.

  • oldprof November 7, 2012  

    Hawaii — It IS an interesting map. Right now it is exacerbated by the redistricting from the last census. In Illinois, the maps were redrawn to the disadvantage of Republicans, including my district. In Ohio, the opposite happened.
    Thanks for the link, which does not work in your email, so I am correcting here: http://oahutrading.blogspot.com/2012/11/counties-won-by-dem-rep.html

  • Bruno V. November 8, 2012  

    Jeff: Understood, will do, looking fwd to it, and thanks for the reply. –Bruno

  • Sample Statements November 10, 2012  

    What is the difference between the bond funds and other funds? I think in every funds people need to have ability to face risk.