Weighing the Week Ahead: How Should Investors Cope with Geopolitical Risk?
Last week I suggested that the market might be ready for some real news—corporate earnings. That is still a key topic, but attention is focused on world events. Pundits will be asking:
How Should Investors Respond to Geopolitical Risks?
Last week the economic news was good, but mostly ignored.
In my last WTWA I predicted that attention would shift to corporate earnings reports. Little did I know that a passenger dragged from a United Airlines flight would dominate the news cycle for the week. Just as that was losing interest, the Trump military actions grabbed the spotlight. So much for my expectation (and hope) of returning to news focused on financial markets.
The Story in One Chart
I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the small daily moves and the 1.13% loss for the week.
Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read his entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.
Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something very positive. My working definition of “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!
There was not much economic news last week, but it was pretty good.
- Port Traffic showed strength in March. Steven Hansen (GEI) helps us sort through a very noisy data series.
- Foreclosures are down, now below pre-recession levels. (MarketWatch).
- Mortgage delinquencies are at a 10-year low. (24/7).
- Small business optimism registered a strong 104.8.
- Inflation tame. PPI and CPI both declined. Some see this as negative news since it is not hitting the Fed’s target. That makes little sense. If the Fed can continue stimulative policy without increasing inflation, so much the better.
- Weekly jobless claims remained low at 234K. This half of the picture remains solid. We also need new hires.
- Michigan sentiment remained strong at 98. The best chart of this indicator is the Doug Short design, now updated by Jill Mislinski. It shows the indicator, recession periods, and GDP. You can easily see the current level versus past records. If only everyone was so clear!
- Retail spending declined 0.2%. (Calculated Risk reports). Steven Hansen has a different take, with multiple historical charts and comparisons. Retail sales are an important sector, so this is worth watching closely.
Fraudulent LIBOR trading went far beyond those on the front line. This story should have gotten more attention because so many swaps and variable interest rates (perhaps your own mortgage?) were linked to this rate. Perhaps that is not a good idea.
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week, but nominations are always welcome. There are many bogus claims and charts out there!
I am disappointed that so many of my blogging colleagues agree with this concept – on a theoretical basis – but do not join me in highlighting these posts. While I do not compete for my own award, I had a post this week that illustrates what I am looking for. There are plenty of “mystery charts” that are unclear, poorly sourced, or cannot be replicated. Sadly, these optical illusions fool many readers.
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. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.
We have a normal week for economic data.
The “A” List
- Housing starts and building permits (M). An advance look at an important sector.
- Leading indicators (Th). Last month won’t be matched but overall strength expected.
- Existing home sales (F). Less important for immediate economic effects, but a good market read.
- Beige book (W). Anecdotal data, but the punditry hungers for any Fed-related news.
- Initial jobless claims (Th). Is the series edging up from record low levels?
The “B” List
- Industrial production (T). March data, but an important sector.
- Philly Fed (Th). Earliest read on April is expected to be strong, but can’t match last month.
Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.
The schedule is back to normal on FedSpeak, with something every day. Earnings season ramps up. World events may well grab attention. Friday is options expiration, which can have the effect of exacerbating big moves.
I would say “fasten your seat belts,” but enough of that already!
Next Week’s Theme
In a normal week, the Q1 earnings season would be the theme. The geopolitical stories are more dramatic, better both for TV clips and online posts. That is certainly an important story, but at WTWA we focus on financial markets. At least some of the punditry will be doing the same. The key question?
How Should Investors Respond to Geopolitical Risks?
There is not a lot of complexity in this week’s theme.
Fear is back in the market.
Credit Suisse updates their fear gauge.
CNN shows an even more dramatic result.
- The fear team advises exiting the market, if you have not already done so based upon prior advice.
- The passive investing team thinks you should “stay the course.” Scott Grannis has a good chart pack and remains “cautiously optimistic.”
- Some see a buying opportunity. (Davidson, via Todd Sullivan).
Earnings expert Brian Gilmartin notes that whatever is bothering the market, it is not earnings!
FactSet’s John Butters agrees.
Those conclusions are important. The data helps us to isolate the market concern: geopolitics, not earnings.
Can investors do better than these three alternatives? As usual, I’ll have a few ideas of my own in today’s “Final Thought”.
We follow some regular featured sources and the best other quant news from the week.
Whether you are a trader or an investor, you need to understand risk. 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.
The Indicator Snapshot
The Featured Sources:
Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment. (see below).
Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.
RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed.
Georg Vrba: The Business Cycle Indicator and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. His interpretation suggests the probability creeping higher, but still after nine months.
Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.
Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating. The latest update now includes the employment data.
The Quarterly JP Morgan Guide to the Markets is available. This is a key resource for data-driven investors. Among the many great charts, investors should compare their take on valuation with those most popular in the blogosphere. Unlike those, there is some recognition taken of inflation and interest rates, especially the bond indicator.
Another key chart looks at what happens when interest rates move higher.
Why? Ultra-low rates are typically associated with deflation fears and massive skepticism about earnings. As the economy improves, both rates and earning move higher. So do stocks.
updates his recession analysis. While his excellent record is not as long as our sources, he has the right idea. It is worth reading his current take (no problem in the foreseeable future) and the comparison to his past calls.
How to Use WTWA (especially important for new readers)
In this series, I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have eight different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:
Are you preserving wealth, or like most of us, do you need to create more wealth?
Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)
Best Advice for the Week Ahead
The right move often depends on your time horizon. Are you a trader or an investor?
Insight for Traders
We consider both our models and the top sources we follow.
Felix, Holmes, and Friends
We continue with a strongly bullish market forecast. All our models are now fully invested. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst (usually me, but sometimes a guest expert). We try to have fun, but there are always fresh ideas. Last week the group discussed three contrarian ideas.
Top Trading Advice
Brett Steenbarger is required reading for traders. My favorite this week is, How Tough Has Trading Been?
Brett collects data from various sources, demonstrating the recent rough patch for many strategies. Then he follows with key advice on how to negotiate these times:
It’s not enough to learn how to trade; it’s critical to trade uniquely. It’s not enough to trade with rules and discipline; one must also find opportunity creatively. The firms achieving the results depicted above are trading trends in liquid markets in a disciplined fashion. A great approach to success would be to research strategies that made money during months when those other participants were performing worst. There is no guarantee that future returns will mirror backtested ones, but digging for gold in well-mined fields is a poor risk/reward proposition.
provides an update on the “oldest market timing system.” Hulbert notes concern among most market timers, and then contrasts with Dow Theory. “All three of the Dow Theorists who I monitor on a regular basis believe the major trend remains up”. Read the entire article to see what might change their minds.
Insight for Investors
Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!
Best of the Week
If I had to pick a single most important source for investors to read this week it would be this article from Charles Schwab’s Liz Ann Sonders. Sometimes the most important investment advice relates to your perspective – the reasons you have in mind for recent market behavior. In particular, if you buy the incessant media chorus of the “Trump Rally,” you will be worried every time a Trump program is stalled. Sonders cleverly shows why you need a deeper look. I cannot quote it without spoiling the story, so please read this excellent piece.
Barron’s looks at drug stocks that could thrive in an era of lower prices. Also underwear! Especially Hanes Brands (HBI) which is cheaper than competitors.
Deutsche Bank (via 24/7) recommends aerospace and defense stocks.
Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. Road Runner finds rising channels and picks stocks trading at the bottom – Targa Resources (TRGP) this week. Warning to investors: Road Runner does not hold positions for more than a month.
Simply Safe Dividends looks closely at Verizon (VZ).
Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is Ben Carlson’s discussion of how much you need for retirement. The answer is different for everyone, of course, and Ben helps you figure it out. Here is a key tool:
Watch out for…
The original “Trump Stocks.” This is what happens when analysts on deadline jump the gun without complete information.
World events provide one of the biggest challenges for investors. A sense that something bad might happen triggers a very human response. Caution seems warranted.
Before offering some criteria, here are a couple of examples that will be unfamiliar to most current readers.
- In the 1980’s the cold war raged. Polls asked a variety of questions. One was whether people thought they would die in a nuclear exchange. About 80% said yes. Later in the poll, people were asked whether they expected a nuclear exchange in their lifetime. About 70% said yes. Putting these two results together showed that most people did not expect to die of old age, an accident or something else. More than half of the US population seemed to expect death from nuclear war. Had that question been asked directly, the answer would probably have been different, but you get the idea.
- Art Cashin, the clever, witty, and wise NYSE veteran has a story about his days as a trainee. You may infer his age, since the incident occurred during the 1962 Cuban Missile Crisis. This was the closest the world has come to a nuclear war. Art’s instructor asked the trainee class how they should respond to the threat of war. Their answers ranged from sell to going short. Wrong! The instructor explained that if we got through this, the market would rally. If not, it wouldn’t matter!!
Naturally, it is not that easy. We need to be realistic about threats and risk. In doing so we must – as always – separate our citizen role from our investor role.
There are several aspects to this question.
- The risk must have a link to financial markets. Ben Carlson has a good history of important events. The results are mixed, which illustrates the key point.
- It is not enough to sell. You must know when to get back in the market. This can be very difficult to do, especially when there is a surprise positive reaction.
- Which risks require action? How much before the possible event? There are always threatening geopolitical situations. There is an active market in fear. My personal conclusion is that risks are much, much lower than they were thirty years ago.
- If you act, what should you do? Sell everything? Go short? Few examine the effect of a modest hedge. It requires careful analysis and may not achieve what you want.
It is important to recognize risk. It is the top priority for my accounts. I am committed to avoiding the next big downturn, which we all know will happen eventually.
You can do that by a perpetual bearish attitude, but most people need some investment returns. It is better to have tools that evaluate market risk. That is a regular mission in WTWA.
Going beyond the numbers you see here, I apply my experience. In 2012, for example, there was risk from the “fiscal cliff” issues. While I expected it to work out at the eleventh hour – and I was right – I reduced position sizes to reflect increased risk. This sacrificed some return, but it was aligned with my mission and our clients’ needs.
Selling your positions because there is a threat is not a good solution. Being a “buy and hold” investor would be better, but not best. Recognizing which geopolitical risks have market relevance is a key skill.