Weighing the Week Ahead: Are We Near the End of the Economic Cycle?
The economic calendar is normal with an emphasis on inflation and sentiment data. None of the big reports is on the calendar, leaving pundits free to take up the biggest current issue. They will be asking:
Are we near the end of the economic cycle?
Last Week Recap
In my last full installment of WTWA I asked whether the Fed would hint at a new course. Impressions from the meeting were mixed. It has remained a prime topic of conversation fueled by Presidential tweets, comments, and potential Fed appointees.
In my “vacation edition” I summarized the most important aspect of the Fed meeting as well as the unusual reaction of the markets. I promised that I would write something if an important issue arose. The questionable analyses of the yield curve fit the bill.
I followed up with Making Sense of the Fed and a deeper look at how interest rate arbitrage is flattening the yield curve. I also sent the Fed piece to clients. Later in the week Goldman Sachs offered similar observations. It is easy to get caught up in hasty reactions to economic news when a complete analysis is required.
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 Jill Mislinski’s data-packed version.
Stocks gained 2.1% on the week. Because of a gap opening on Monday, and a close near the week’s high, the trading range was only 1.5%. You can see volatility comparisons in our Quant Corner.
Let’s also review the December drawdown. Jill’s chart provides both a long-term perspective and context for the Q1 rebound.
Only the October, 2011 pullback was in the same range.
I enjoyed the Visual Capitalist’s presentation of technology hype cycles.
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!
When relevant, I include expectations (E) and the prior reading (P).
New Deal Democrat’s high frequency indicators are an important part of our regular research. Long-term indicators have retreated to neutral, as did the nowcast. Short-term indicators are negative. He expects further deceleration this year.
- Construction spending for February increased 1.0% versus expectations for a decline of -0.3%.
- The ISM manufacturing index increased to 55.3, beating expectations of 54.1 and February’s 54.2.
- Initial jobless claims were only 202K, beating expectations of 217K. Bespoke observes that this is the low point for the cycle, but prior low prints were later revised upward. Their chart is a nice combination of long-term perspective and a closer look at the last two years.
- Nonfarm payrolls showed a net gain of 196K, relieving concerns about February’s 33K, upwardly revised from 20K. This report was excellent on many fronts beyond the headline number. The report on labor force participation of prime-age workers is encouraging. (WSJ)
As always, some scoured the subgroups to find a sector showing a small decline. Business cycle expert James Picerno concludes that “the probability is virtually nil that a US recession has started.” He emphasizes a key takeaway:
Today’s update serves as a reminder that relying on one data point to evaluate business-cycle risk usually delivers misleading results in the extreme. But even if you were inclined to use the disappointing February jobs report as a guide, focusing on the more reliable one-year change still suggested that the economy was expanding at a decent if slower pace.
- Retail sales for February declined -0.2% after a prior gain of 0.7% (revised from 0.2%) and expectations of a gain of 0.2%.
- ISM non-manufacturing for March registered 56.1, missing expectations of 57.9 and the prior reading of 59.7. You can get some additional color by reading the comments at the ISM site.
- Durable goods orders for February declined -1.6%. E -0.9% and P 0.1% (revised lower from 0.4%). Ex-transportation the miss was only 0.1% versus expectations of 0.2%.
- ADP private employment showed a March gain of 129K, missing expectations of 178K and a prior of 197K.
- Little progress on China trade issues, but talks will continue. (MarketWatch).
Drug-resistant germs. And the secrecy surrounding the incidents. Have you heard of Candida auris? (NYT).
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.
We have a normal economic calendar with the highlight on inflation and confidence surveys, but none of the big economic indicators. Some will scrutinize the FOMC minutes, trying to find new information. Data wonks will prefer the widely-misunderstood JOLTS report, which is the best indicator on labor market structure, but provides nothing fresh on job growth.
And of course, stay tuned for anything new on the DC soap opera, which so far has had little market effect.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The calendar – moderate and without the top releases – provides the chance for the punditry to take up the most important issue of the bull/bear debate. Expect pundits to be asking:
Is the end near for this business cycle?
The Current Viewpoints
Bob Pisani, who does an excellent job of summarizing current trader viewpoints, highlights the economic debate as the key bull/bear distinction. While business cycle analysts have been following this continuously, we now see many more joining the discussion.
- The most popular viewpoint begins with the “aging bull” thesis. People are conditioned to make historical comparisons without much analysis of the comparability. This has helped to drive many average investors in a search for yield, believing that this is less dangerous than finding cheap stocks. The result is a crowded trade in utilities and so-called “defensive” names. I Googled Barron’s + aging bull and got a long list of stories over seven years or so. Other sources had similar results.
- Many continue to expect a recession, just moving the date by a year or so when it does not happen. John Mauldin’s recession series, which includes the usual long list of things someone might worry about.
The business cycle does not matter (or cannot be forecast). Josh Brown debuted a new series on CNBC, where he will explain some aspect of the market in each episode. Historically he has been a favorite on WTWA and I have often cited him (via Twitter) as the most sensible and informative participant on CNBC. His presentation, describing economics and the market was mostly first rate. Drawing upon Marty McFly’s fictional use of sports data to win bets, Josh observes:
What about doing this with economic data? Let’s say I told you what the unemployment rate would by one year from now, or gave you the next four quarters’ worth of GDP growth, or even how many times the Fed would hike or cut. Then what? Your ability to use this information in the context of an investment portfolio would be pretty disappointing.
Because the stock market isn’t a bet on the economic data. There are so many other variables that go into what prices people will be willing to pay for what investments that even if you knew the economic picture in advance, you still wouldn’t be able to use it the way you would a sports almanac.
In the CNBC video he makes an excellent distinction between economic results and the market in the short term.
Typically, the economy trudges along a straight path for years at a time and it’s the stock market that is easily excitable, ripping to and fro based on the latest information to hit the tape. Over longer periods of time, we do see a correlation between stocks and the economy, but over periods of less than a year, there is literally no rhyme or reason for what has happened. All explanations are simply ex post facto; an expert grasping at straws to assemble a reasonable take on what has occurred, and why it ought to have been obvious to everyone.
Well put! But then we get the investment advice, which seems inconsistent with the reasoning – at least for the long-term investor.
Investors are not well served by incorporating economic expectations into their long-term investment plans for the following reasons:
- The future is impossible to predict.
- Even if you knew what would happen in the future, you would still have to guess about what that might cause buyers and sellers to do, and how sentiment might shift in the investment markets.
- There were many years during which stocks have rallied as the economy had performed worse than expectations. There are also years during which economic data was strong but stock prices were weak. And then we’ve seen literally everything in between. No one can reliably predict which of these scenarios is more likely to occur in advance.
Understanding the economy is a helpful exercise. Placing market bets as a result of this understanding is a carnival game on the midway.
- The bull market might have much longer to live, despite the age. Surprisingly, Barron’s cover story, This Bull Market Has No Expiration Date, raised this very possibility. And I’m sure many people will cite this story as a contra-indicator! Barron’s cites several analysts with differing reasons for this possibility. If none of it sounds new, and you are a regular reader, I am not surprised. Some of the key points:
So much bearishness rests on the fact that the current recovery has lasted for more than 10 years. “People are superstitious because the bull market has been running so long,” says Andersen Capital Management’s Peter Andersen. “Their intuition says it doesn’t seem like it can last much longer.”
“Hardly any economic indicators show that there will be a recession,” Andersen says.
Or that the economy is overheating. The Atlanta Fed’s GDPNow model predicts 2.2% growth during the first quarter of 2019, near the annual average of 2.3% since 2010. Capital spending still hasn’t reached levels seen during previous recoveries. Inflation is still muted. As long as that remains the case, there will be no need for the Federal Reserve to tighten the U.S. into a recession.
The article continues with analysis from three prominent strategists, who cite favorable Fed policy as a key tailwind and a tighter labor market as a concern. One has an interesting theory about mini-cycles within the bull market run, throwing off the traditional timing.
And of course, resolving the trade dispute with China is important.
Understanding these issues is the single largest challenge for the individual investor. I’ll offer my own conclusions 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 and long-term technical conditions continue at the most favorable level. Our fundamental indicators have remained bullish throughout the December decline and rebound. The C-Score reflects the flattend yield curve. I am watching this closely, including analyzing signs of possible confirmation.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
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. With Friday’s employment data, it is time for an update of the Big Four, the indicators most important for recession dating.
A recession is marked by a significant decline in these indicators, not a just a slowing of growth. Sales and income will be especially interesting to watch.
The quarterly JP Morgan guide to the markets is out. As always, it is packed with important data and charts. More to come from this source.
Brian Gilmartin provides an interest analysis of upcoming earnings. He accurately predicted the distortion of the normal pattern of revisions thanks to the Tax Cuts and Jobs Act. He expected a decay in forward estimates until the quarter started. He highlights they key sectors while pondering whether Q1 will represent a bottom.
Insight for Traders
Check out our weekly “Stock Exchange.” We combine links to important posts about trading, themes of current interest, and ideas from our trading models. Last week we asked fellow traders about their risk per trade. As usual, we discussed some recent picks from our trading models. Felix rated the top twenty stocks in the Russell 1000 and Oscar did the same for the most liquid ETFs. Pulling this altogether was our regular editor, Blue Harbinger.
Insight for Investors
Investors should embrace volatility. They should join my delight in a well-documented list of worries. As the worries (shutdown, Fed policy, trade) 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 Vitaliy Katsenelson’s Why Investors Shouldn’t Watch Business TV. Most of the daily action is random. He writes, “I feel for TV producers who must provide a continuous narrative to explain this randomness.”
Here is another key point:
Business TV presents additional dangers to your rationality: It reprograms you to think about the stock market as a game. In encouraging you to play that game, it puts you at risk of nullifying all the research you’ve done, as you let your time horizon dwindle from years to minutes.
Chuck Carnevale continues his sector-by-sector search for bargains. This is Part 13. Chuck is especially tough on the stocks in the Non-Energy Minerals Sector. He is unhappy with the lack of consistency of returns and dividends. Reviewing his methods and how to apply them in this sector is important even if you don’t find an idea or two.
Disney versus Netflix. Barron’s notes the strength in DIS before next week’s investor day and cites some recent upgrades. Lyn Alden Schwartzer takes a deeper look at the competitive strategies and valuations.
Industrial stocks? Even if the economy slows? Barron’s interviews Barclay Analyst Julian Mitchell who illustrates the theme with a microcap idea.
If you invest in microcaps you should stay small and diversify. Bhavneesh Sharma describes T2 Biosystems (TTOO), which has developed a rapid pathogen diagnostic testing process. Sepsis is the first market – and it is a big one.
30 undervalued stocks from Morningstar. There is a sector breakdown which readers might compare with some of Chuck Carnevale’s conclusions. Note also that utilities are trading at a 10% premium to their estimates. More detail on the sector is published here.
Ralph Vince, a leading expert on portfolio mathematics, the development of trading systems, and author of five books, has been right on the equity market for years. He has a strong opinion. Read the whole post for other indicators, but here is a key section:
“If the best horse always won, this stuff would be so easy,” the Old Frenchman used to tell me.
But it sure helps when the best horse is running against a field of nags. Similarly, I don’t recall, in forty years, what appears to be a easier setup than right now in equities.
Not even close. Ever.
Let’s start with the backdrop, which is decidedly negative at least in terms of recent news – global slowing, yield curve inverting, earnings trailing off etc.
Now, let’s just look at the reality. In terms of what’s going on with rates–a contrived situation on the short end, entirely inconsistent with quality spreads which have narrowed in the past couple of months, considerably, even with respect to junk.
Whatever global slowing was going on in 2018 has decidedly and abruptly turned. Since the first of the year, Shanghai is up 24%, Oil is up 27%. Global Slowdown?
To think we’re still in a slowdown period is to miss what’s already going on.
Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Each week he highlights stories of interest for both advisors and investors. His consistent creativity highlights new angles and familiar problems. This week I especially appreciated his excellent discussion of absolute return. See the full discussion and links. Your needs do not always correspond to a benchmark. Gil also had a great post on How Safe Should Your Portfolio Be? Reading the two posts together is especially interesting.
Abnormal Returns always provides interesting ideas on a wide variety of topics. The Wednesday edition is focused on personal finance. This week I especially enjoyed Ben Carlson’s discussion of how to create your own pension – featuring the role of Social Security and when to defer collecting until age 70. It is too complicated to summarize here, but my experience with clients confirms his thesis:
Since so many people are woefully prepared for retirement in terms of their assets, Social Security will be required to play an important role in retirement planning for a large number of the population.
Watch out for…
NAFTA 2.0 delays. I am cutting back on some related positions. My expectation is that the legislation may not emerge before Labor Day. These stocks are also threatened by the (possible, but unlikely) border shutdown.
The process of replacing LIBOR continues. Most people either don’t know or have forgotten what this is and why it is important. Timothy Taylor has a good overview of the change and possible effects.
Most financial commentary comes without any assurance about the presenter or the quality of the research. I love the CNBC box that shows “Street Cred.” It usually means that the speaker is one of thousands of employees at a big firm. After extensively reviewing many recession warning systems, I have one definite conclusion: None of them is useful beyond a period of a year. Predictions are especially unhelpful when they include a general warning based upon pop economics or confirmation of investor intuition.
The ability to recognize real risk in the economy, financial markets, and corporate earnings is the single most important skill. You need not be a forecaster or market timer. You must get out of the way when the odds of danger are high. It will not be enough to own utilities or an “all-weather” portfolio. Risk recognition also permits you to be more aggressive when there is opportunity. No one knows how much longer this economic cycle or bull market might last. All we know now is that we probably have at least a year.
I look forward to the remaining Josh Brown installments, but I hope he will reconsider his ideas about the significance of the economy. He agrees that it matters in the long run. He recently interviewed Tony Dwyer, a “famed Wall Street strategist” and included his recession indicators. Dwyer’s methods are similar to those I have championed for almost nine years. It is no coincidence that we have both been comfortably bullish. So many investors are bamboozled by random and bogus explanations. They need clarity and accuracy from industry leaders.
A credible recession warning should not be ignored. Nearly all major market declines are associated with recessions.
If you include the SLFSI, reported here weekly, you have two excellent early warning methods.
Do you need more dependable investment income? Are you taking on too much risk? Send an email to main at newarc dot com. We’ll provide some helpful free information, and at your option, a no-charge portfolio consultation.
I’m more worried about:
- Brexit, although a significant extension seems likely.
- US/China trade matters. The activity is visible, but there is little sense of real progress.
I’m less worried about
- The Fed independence and policies. We may be surprised at the lack of impact from the suggested appointments. Even if appointed and approved, it is difficult for those without expertise to prevail in such an environment.
- Recession concerns, especially as we move past Q1 data and get some stability.