Weighing the Week Ahead: Focus on Housing

Forecasting market moves is always a challenge, but the recent months have been especially difficult.  I see three reasons:

1. Fundamental data have not provided a clear direction.  This is typical in times of modest growth.  Economic data provide an inconsistent pattern, although most observers impose their own interpretation on the results.
2. Technical data do not provide a clear direction.  Most observers impose their own interpretation on the results.
3. Everything is correlated.  The reward for stock and sector selection is lower, since there is much less variation from the overall market.  The focus on the simplisticly named “risk on, risk off” trade does seem to capture the current lack of imagination.  The correlation of stocks is .81, double the historical value.

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.

Last Week’s Data

Last week’s call was pretty accurate — thin volume with the opportunity for varying interpretations.  Here is what I found to be most important.

The Good

• Industrial production upticked and capacity utilization is at the highest level in two years.

• The ECRI Index improved to the highest level since June.  The debate continues between those who created the index and employ additional data in making recession calls and those who are making inferences from published-only data without even knowing the index constituents.

• Earnings, despite skepticism, continue to show strength.  For many of us the market seem to be mispricing technology stocks.  I especially apprecitated the data-based work of Chuck Carnevale, who compared earnings growth and stock prices in Oracle (ORCL) and Research in Motion (RIMM).   The article shows the opportunity for strong fundamental analsyis.  If you read the comments, you get a good picture of the opinons of partisans, and why you might want to be a contrarian.  [Full disclosure – I am long both stocks in personal and client accounts.]

• The market reaction — solid in the face of modest economic data.  The S&P 500 is back above the 200-day moving average, testing technical resistance at the high end of the recent trading range.

 

The Bad

There was bad news, but it had a mixed quality.

• The small business index is still in “weak or recession territory” although it registered a small uptick this week.

• The Philly Fed report was slightly negative (-0.7), but an improvement from last month’s -7.7.  This was a little worse than the consensus forecast and the fact that it was negative got a big media play.  This is a diffusion index (are things better or worse on various factors) and a a survey.  No one asks about a margin of error or worries about late-arriving answers.  I am interested in the report, but it is very noisy.  People make too much out of small changes.

• The housing stories were all very bearish — three-year inventory, foreclosures higher, prices falling.  The inventory is a little deceptive, since it is based on the last month’s annualized sales.  If sales were to move higher, the inventory could change a lot.

• Weekly jobless claims were 450,000.  I continue to call this a negative, since it is not close to the level needed for solid net job growth.  On the other hand, those who claimed last week that the improvement was due to seasonal factors or a holiday-shortened week were wrong.

 

The Ugly

• Consumer sentiment, as measured by the University of Michigan, declined to 66.6, the lowest level in more than a year.  Calculated Risk rightly observes (check out the article for the helpful chart) that this is a lower level than the market-moving July reading.  Regulare readers know that this is an important element of my employment model, since it captures information about job creation as well as layoffs.

• In a curious juxtoposition, investor sentiment is turning bullish, another negative for the contrarian observers.  Is this confusing enough for you?  Recession fears subside and the year-end market is called higher.

Check out the charts on both, with all of the bearish implications at a new site, Global Economic Intersections, featuring some of my most popular contributing colleagues at Seeking Alpha, Steve Hansen and John Lounsbury.  I wish them well.

The Week Ahead

The housing stories already have our attention, and this week provides fresh data.  We will see data on housing starts, building permits (my own favorite leading indicator of housing), existing home sales, and new home sales.

The political debate over extending the Bush tax cuts will continue, as will the various jobs programs.

I do not view the so-called leading economic indicators as very important, but I am always interested in the initial claims.  The week after options expiration often has a slight negative bias.

Finally, we will all be wondering whether the trading range breaks to the upside.

Our Own Forecast

We remain bullish but cautious, with most sectors in the penalty box.  This is a recognition that we cannot have great confidence in most short-term prediction.  When a sector is in the penalty box, we know that forecasting future moves will be challenging.  Despite this, the picture has improved enough to continue our bullish posture, in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

•  93% of our 55 ETF’s have a positive rating, up from 78% last week.
• 91% of our 55 sectors are in our “penalty box,” similar to recent weeks.  This means that uncertainty remains high for short-term trading.
• Our universe has a median strength of +29, up from +18 last week.

For trading accounts, we had a 60-80% exposure during the past week.

[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 email list.  You can also write personally to me with questions or comments, and I’ll do my best to answer.]

Conclusion

Our short-term and long-term models are back in bullish agreement.  The short-term model can and often does change quickly.  It should be another interesting and challenging week.  Readers my agree or disagree with my conclusions.  That is fine.  I hope that most find my “thinking out loud” exercise to be helpful.