Weighing the Week Ahead: Good News from the Government

Regular readers know that I have been expecting a compromise on the extension of the Bush-era tax cuts.  This now seems to be a reality.

This is unabashedly good news.  Best of all, the market will not react to this right away.

Now is the time for investors to enjoy a new bull market.

 I’ll return to this theme, but let us first review last week’s data.

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.

Last Week’s Data

The important US data from last week basically continued the encouraging story.  We finally saw a significant market reaction, still linked to dollar weakness.  Let’s take a closer look.

The Good

Economic news continues to beat expectations.

• The ISM index was 56.6, a level consistent with nearly a 5% growth in GDP.  This is an important non-governmental index that has had good correlations with the economy in the past.  It is worth watching, and an important factor in my own analysis of employment.
• The ECRI growth index is still slightly negative, but at the best levels since mid-May.  The ECRI said four weeks ago that a near-term recession was off of the table.  Each week we have more evidence that they are correct.  It is also apparent that those who made dubious interpretations of the ECRI indicator were wrong.  I tried to demonstrate their error back when readers could still profit from the knowledge.
• Consumer sentiment from the Conference Board is confirming the Michigan survey.
• Goldman Sachs upped their GDP forecast for next year to 2.7% from 2.0%.  But what do they know?
• The story is the same on many fronts.  Excellent sources like Bill Luby and Bonddad demonstrate a consistent pattern of economic improvement.  I strongly recommend that you follow the links to both sites and see the excellent data-based analysis of the economy.  Meanwhile, their readership is dwarfed by sites like ZeroHedge, where the story is all bad, all of the time.

Why the persistent bearish spin has such a grip is the subject for a much longer and deeper analysis.  Meanwhile, this reality is an obvious investment opportunity for those who use brains rather than emotion.

The Bad

There was also some discouraging news.

• The employment report was bad news.  The job gains are still small compared to what is needed.  The unemployment rate moved higher.  This may be the last economic indicator to turn, but we need it.
• Weekly jobless claims did not continue the downtrend.  We need these to get under 400K.

The Ugly

Stocks continued to trade on the basis of European rumors and dollar correlations, but eventually rallied  The path for investors will be much clearer when the impact of such news is reduced.  Those waiting for a perfect resolution will also miss out on most of the rally.

The drumbeat of international news maintains a climate of fear for the individual investor.

Our Own Forecast

We base our “official” weekly posture on ratings from our TCA-ETF “Felix” model.  Felix caught most of the recent rally, moved to neutral (but with several trading positions) and has turned postive again this week.  The number of sectors in the penalty box, a sign of near-term risk, remains high.  We are shifting our brief neutral posture to bullish in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

• 64% of our 55 ETF’s have a positive rating, up from 43% last week.
• 89% of our 55 sectors are in our “penalty box,” down slightly from 93% last week.
• Our universe has a median strength of +9, up nicely from -7 last week.

The overall picture became more positive during the week, and we added to trading positions, moving from 80% to 100% invested.

[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.]

The Week Ahead

Most of the investment punditry makes money by acting smart when they disparage official data, projections, and events.

Sometimes the obvious answer is the right one!

The compromise legislation that will be passed in some form will extend the Bush-era tax cuts, keep dividend taxes low, and avoid a big increase in the AMT (alternative minimum tax). Most importantly, the changes will provide a 100% investment tax credit and also extend long-term unemployment benefits.

I want to stress how poorly traders and investors analyze policy changes.  The emphasis is on the anecdote and what people think they already know about economics.  Meanwhile, most people ignore the actual impacts.  Take a look at this very helpful chart from Menzie Chinn, one of our featured sources.

Professor Chinn notes that the change is worth 0.6% in the GDP.

Since most people do not understand this, it becomes good news that will play out over time.  Think of it as insider information, available only to those who know how to interpret objective data and economic analysis.