Weighing the Week Ahead: Why is Everyone (Else) so Confused?
The economic calendar is modest, but important, with an emphasis on inflation and confidence – both business and consumer. We will see reports from over 60 S&P 500 companies, and the results of the New Hampshire primary. That includes plenty of real news, but I expect a somewhat different focus. Last week was unique. I have never seen such a struggle to find a daily reason for stock market shifts. Even the traditional method of getting the result first and then manufacturing a reason left heads shaking. When the facts seemed so clear to traders and pundits, why was the market not following the obvious fundamentals?
Expect to hear the question:
Why is everyone else confused and out of step?
Last Week Recap
In my last installment of WTWA, I analyzed the Coronavirus outbreak from several perspectives: health, the economy, and investments. It was a challenging topic and one of my most difficult posts to write. My conclusion – that there was no need for panic and time to analyze what was happening – was on target. Those who remained cool and analytic had a nice week. I am not declaring that this health crisis is over. I continue to monitor the excellent collection of references I identified last week.
This was a big part of the financial news last week, but there was also the impeachment decision, the State of the Union speech, and the results (do we have them yet?) from the Iowa caucuses. As I suspected, economic data and corporate earnings took a back seat in the news, but perhaps not in the minds of investors and fund managers.
I must follow up on the big game. Mrs. OldProf was cheering for KC. My parlay (49’ers and under) was looking good until very late in the game. Like many decisions, a well-reasoned process may have edge, but it doesn’t always work. The only way to know for sure is to have hundreds of similar cases. That keeps it fun. Meanwhile, she is merely laughing and collecting what I owe her.
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 approach – one that illustrates several key variables.
The market gained 3.2% for the week. The trading range was 3.5%, although the big moves gave it the feel of higher volatility. As you can see from the chart, much of the action occurred in the overnight market for the US. The Asian and European markets echoed the prior day’s result in the US. Putting aside the gap openings, the intraday trading was pretty quiet. This is a challenge for traders. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.
Statista takes a look at Where Americans Lack High-Speed Internet Access.
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. This report is fact-based and consistent with the choice of indicators. Consideration of three different time frames helps to clarify economic changes. This week all time frames are positive, including the volatile short-term indicators. NDD has been monitoring the issue of whether manufacturing weakness will be a drag on the consumer. This week he concludes, “Once again, the American consumer has come through.”
- Mortgage applications showed continuing strength, up 5% on the week.
- Mortgage rates are making new lows.
- The ISM Manufacturing Index for January rebounded to 50.9 from December’s (upwardly revised) 47.8. This beat expectations of 48.1.
- ISM Non-Manufacturing for January registered 55.5 slightly better than expectations of 55.0 and December’s 54.9.
- Factory orders for December grew 1.8% beating expectations of 1.1% and much better than November’s (downwardly revised) loss of 1.2%.
- Initial jobless claims surprised with a decline to only 202K. This beat expectations of 218K and the prior week’s 217K.
- Rail traffic is expanding including gains in Steven Hansen’s (GEI) economically intuitive sectors.
- ADP private employment for January grew by 291K, much better than expectations of 160K and December’s 199K.
Small companies were solid contributors.
The official payroll report for January was basically positive.
- Nonfarm Payrolls grew by 225K, much better than the expected 164K and December’s 147K.
- Labor force participation increased, helping to explain an uptick in the unemployment rate from 3.5% to 3.6%.
- Average hourly earnings grew by 0.3%, in line with expectations and better than December’s 0.1%.
Employment report benchmark revisions were officially announced an included this month. For some, the idea of revising a report implies some sort of shenanigans. On the contrary. Initial reports, often based upon surveys, are improved as more data becomes available. Would we prefer to remain ignorant of the better evidence? Some embrace the use of market data since it is not revised. Wrong! It is revised by the market itself when first impressions prove to be wrong. This is a great topic for another day. The employment revisions included numbers from state employment offices and the most recent census population controls. This is done to keep the monthly reports in line with the most recent and best data. The revisions show that the overall job growth for the year ending in March 2019 was overstated by a total of about 500,000. The discrepancy was spread out over the year, so it is more important for the total than for a specific monthly change. Regular readers know that I emphasize checking the QCEW and Business Dynamics series as a “scorecard” of estimates made nine months earlier. The estimates were running a bit “hot,” so the revisions are no surprise. Here is a good look at the aggregate effect:
And here is Prof. Menzie Chinn’s analysis.
And some support from Dr. Chinn about the need for confirming QCEW data.
I also emphasize the ADP results. These employ a sound and different method from that of the BLS. Some want their numbers to match the BLS. It is more important that they match reality. I like the confirmation of strong job growth from both reports this month.
- Construction spending for December disappointed with a decline of .2% while a gain of 0.4% was expected. November was upwardly revised to a gain of 0.7%.
- Earnings reports are below the five-year averages for the beat rate (only 71%), the size of the beats (only 4.6%) and the size of sales beats (only 0.7%). The percentage of sales beats (67%) is better than the five year average. Here is a chart of revenues by sector. (FactSet). Despite this, earnings are on track for the first positive quarter in a year.
Earnings conference calls are a good test of the actual numbers and often more important to investors. The Transcript provides a nice summary of what is said, adding color and nuance to the reported numbers. Here is their summary of reports so far:
Succinct Summary: The year got off to a strong start. There’s a high level of optimism which has helped fuel industries that rely on long term confidence like M&A and construction. Can the Coronavirus halt the economy’s momentum? Seems unlikely.
The report includes specific quotes from corporate executives. These are grouped by a strong start, optimism, better M&A, better construction, and resolution of some old worries.
There are also comments about the impact of the coronavirus for both store closings and supply chains.
Coronavirus, bird flu, swine fever: Why China is still so susceptible to disease outbreaks. There is a conflict between tradition, local government, and central government regulation. Live animals in wet markets are a key part of the problem.
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 economic calendar touches some important bases. Confidence remains crucial for economic growth; we have both small business and consumers featured this week. Inflation is a quiet, largely unrecognized threat to the market rally. This week we get both the CPI index and JOLTs. The latter report is usually interpreted as something about the pace of job gains. Wrong! That is what we saw in the past week. This will tell us about incipient labor market tightening. Retail sales and industrial production are key elements of recession monitoring.
In addition, we’ll get the New Hampshire primary results and another big batch of corporate earnings.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
Once again there are many candidates for the weekly theme. Last week dented the normal pundit certainty, since the daily moves challenged their normal ability to invent reasons for each 1% change. I have never seen so much head shaking. Since I expect it to continue, we’ll see the question:
Why is everyone else so confused?
Market participants each have a “world view” which is difficult to change. Conflicting information generates cognitive dissonance. This requires some explanation to “resolve” the conflict. Last week seemed to set a record. It was more confusion than resolution. Mike Williams tees up the choice:
We can participate in the fear-laced world of perceived ghosts and goblins (and zombies).
Or we can pay attention to our goals, our pathway, our years of wealth-building ahead.
To navigate next week’s opportunities, it is helpful to understand this dynamic. Here are some ideas about what was happening.
Why is the market rallying in face of so many threats?
There were news-driven changes. Many scare stories hit social media and went viral. (Mrs. OldProf gave me permission to say that, so blame her). Here is a good example, but there were many, many more. I’m not going to repeat all of the false stories.
There were reports about potential vaccines, often before U.S. markets opened.
On February 3, Flu and HIV Drugs Show Efficacy Against Coronavirus.
There was solid data showing a dramatic incidence increase in China.
This is a great source for updated results: https://gisanddata.maps.arcgis.com/apps/opsdashboard/index.html#/bda7594740fd40299423467b48e9ecf6. At the time I am writing this there are over 37,500 confirmed cases and over 800 deaths.
There is plenty of suspicion about the official Chinese data.
Taiwan News reports some briefly-posted information from Tencent – quickly changed from higher incidence to numbers in line with official statements.
As always, a new worry generates a new bundle of experts to help us. A close look often shows that these are old experts who now claim knowledge of a new field! Many of them have strong opinions about your investments. I spent most of the week learning from some experts who were new to me. I then pieced together a series of points that covers the key questions. As you will see, it is not specific advice, but it should be a good guide to your own analysis.
Others suggest that the official definition of the disease is only capturing the most severe cases, “using a case definition that cannot capture patients with mild illness, according to experts familiar with the surveillance efforts.” (Statnews).
Wisdom Tree provides a balanced viewpoint suggesting a GDP drag of about 0.5 to 1.0% for China and 20-30 bps for the world economy.
Since spread outside China is still limited, there are some optimistic GDP estimates, showing a one-quarter effect.
Bernie Sanders leads in the New Hampshire polls. Barron’s explains “What This Means for Stocks.” After summarizing polling data, here is what to worry about:
Sanders has long supported Medicare for All. While implementing the so-called single-payer health-care plan he favors would require a tough legislative battle, a Sanders win in New Hampshire, along with strong performance in other early-voting states, would make it clear that Democrats are moving leftward on health-care policy broadly.
Sanders and Warren, who has also supported Medicare for All, pose the most risk to health-care stocks, UBS analyst Keith Parker said in a recent note to clients. And more broadly, Parker found that every 10-percentage point rise in Sanders’ and Warren’s polls “points to a ~1%+ decline in the S&P 500 based on the 2 [week] rolling relationship.”
I have repeatedly opined that this fear has little foundation. James Pethokoukis agrees.
Day of the Week
Finally becoming accustomed to a resumption of the stock rally, the analysts were at a loss to explain Friday’s decline. Finally I started hearing, “It is Friday.” The idea was that people were worried about what might happen over the weekend. Judging from the overnight market effects last week, it could be a mistake to assume bad news will happen while the U.S. market is closed!
I’ll describe my own approach to this difficult question 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.
Both long-term and short-term technical indicators remain neutral, but weakened despite the rally.
The C-score remains in a zone which suggests that we watch for confirming data. Like others, we don’t see much of that. The yield-curve flattening will show up in the indicator next week.
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.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.
Q1 GDP forecasts now range from 1.0 to 2.7%. (Calculated Risk)
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 The Yield Curve Is Now Irrelevant from “Davidson” (via Todd Sullivan). While I am not completely on board with the dramatic title, there is plenty of great analysis packed into this short post. The key point is that the historical yield curve relationship reflects the “net proxy” of interest margins at banks and the pace of lending activity. This has been a key element of past recessions.
With the emergence of high-speed computerized trading to be first to market when a market signal has been triggered, algorithms of all types are now in use to operate buy/sell programs on swaths of issues to execute trading instructions at a pace well beyond human abilities in past market cycles.
But the algorithms are locked into past relationships while “the conditions which led to usefulness of indicators over time may not hold today.”
In the US, the Natural Rate, a fundamental measure of market capitalization based on Knut Wicksell’s economic observations from 1898, reveals that capital flows began to impact 10yr Treasury rates in 2001. The 10yr rates had till 2001 remained above the Natural Rate. Since then 10yr rates slipped progressively lower from the Natural Rate. Rate structures which historically represented capital flows within one’s own markets with known economic impacts now reflect an entirely different set of global criteria. Today, this results in a 10yr Treasury rate of ~1.6% vs. the Natural Rate of ~5%. Today, every foreign political/economic scare drives the US$(US Dollar) higher and the 10yr Treasury rate lower. A persistent misperception in Western markets is the belief that Central Bankers have forced rates into negative territory with investors acting self-destructive. Not so! This is the action of foreign capital seeking safe havens away from deteriorating domestic situations.
Banks have also shifted revenue generation away from net interest margins towards fee-for-service. While narrowing of the yield curve does lower net income margins, the impact on lending is far less today than in the past. A series of 4Q19 reporting by the banking sector underline how little the impact they have experienced from recent yield curve inversions.
Read the full post for a more complete elaboration of the argument. Davidson suggests indicators he regards as better business cycle measures.]
Beth Kindig takes a careful look at Salesforce.com (CRM) reviewing valuation, cloud presence, the effect of acquisitions, and the technical picture. The analysis helps find a good entry point for those who are considering an investment. Beth illustrates the sort of work you need to do if you are an aspiring tech investor.
Bhavneesh Sharma’s unique background helps him produces ideas like this one: Myovant Sciences: Bull And Bear Cases And Investment Decision
Chevron: Some Pain But The Company Still Looks Attractive
concludes Daniel Jones. Check out his post to see the chances for a rebound from last quarter’s earnings.
Verizon: Mixed Performance, Great Investment
concludes D.M. Martins Research.
Barron’s speculates, Energy Stocks Might Finally Have Hit Bottom.
Colorado Wealth Management analyzes the apartment REIT sector.
Blue Harbinger analyzes GasLog Partners (GLOP), explaining the nuances of the most recent earnings call and the resulting attractiveness of the 9.6% yield preferred units. He also carefully discusses the risks.
Brad Thomas remains “cautiously optimistic” on Brookfield Property (BPY) (BPR). This helpful analysis provides background for the mall-related retail environment. It is good reading for anyone interested in this space, not just those considering Brookfield.
The Great Rotation
Change in the growth to value ratio is coming – likely over the next two years.
But it was stronger at the end of 2019 than the start of 2020.
And it will probably work for many years.
Watch out for
High dividend ETFs. Michael F. Gayed looks at one prominent example and concludes:
The Fidelity High Dividend ETF (FDVV) is a good example of a rising star in the dividend ETF space that’s failing to live up to its promise. Part of it is due to its portfolio positioning in the current marketplace. Part of it is due to its portfolio methodology in general.
He explains the problems with their approach, starting with the emphasis on the trailing 12 months which “gives no indication of how safe the dividend is in the future.” The analysis could probably be applied to most dividend ETFs (including the ones you own). Here is the sector breakdown for FDVV:
I am doing some head shaking myself this weekend. I had a jocular comment last week that some would be wondering what the Fed was going to do about the coronavirus. Some joke! Not only did I see this question but also the assertion that the Fed was responsible for the Tesla short squeeze. There were also those wondering whether the Chinese stimulus measures including buying the US S&P 500. These are extreme examples of my main theme. When you start with a world view you find confirmation as well as a method to dismiss contrary evidence.
Those on my “reliably bearish commentary” Twitter list are very intelligent, which makes them especially able to invent plausible explanations! Everyone else is out of step with their version of reality.
I expect some continuing volatility, at least in the short run. Every week I write that volatility is the friend of the investor. Mr. Market comes to you with an often-silly offer to buy or sell stock. If you think he knows more than you, it leads to chasing past performance and some very silly decisions. The alternative is to sell when the offers are high and buy more when they are low.
You take what the market is giving you, but you must know what your companies are worth.
And do not demand instant gratification. I can’t predict when markets will become more rational and neither can you.
Great Rotation Hint of the Week
Patience! The signs remain attractive for all relevant themes, but the economic impacts of coronavirus will temporarily obscure some of the trade rebound effects. Add to your positions on this theme, but there is no need to rush. Home builders remain among my favorites. There is continuing skepticism around these companies which is helping to keep the stock prices low, despite the recent strong moves.
[I’m getting questions about the Great Rotation. I have described the themes for several months. I am trading this approach in a few client accounts as well as my own. I am excited about it. It is not yet an official program for us, but I hope it will be soon. You can sign up for no-charge regular updates, including some specific ideas, by writing to info at inclineia dot com].
Some other items on my radar
- Election news. I still don’t see it as a big market influence, but it bears watching.
- Iran – quiet but simmering.