Weighing the Week Ahead: The Confusing Effect of Politics

Each week I ask myself about the biggest challenge for the average investor.  This week it involves the political debate.

Free speech is a founding principle of the US version of democratic government.  That includes wide-ranging and open debate where facts are exaggerated, opposing positions distorted, and evidence chosen for emotional impact.

Let’s take a simple example, chosen because it is obvious.  This week there was a lot of publicity about a poll by the universally respected Pew Research Center.  They asked about President Obama’s religion.  18% (incorrectly) believe that he is a Muslim and 43% do not know his religion.  Both of these numbers are up dramatically from past polls.

There is a similar increase in people believing that he was not born in the US.  34% of Republicans believe that he is a Muslim.  Many people do not know that the stimulus package included tax cuts.

The significance?

The strident political debate is costly to investors!

Let us extrapolate a bit.  There are many questions that are not simple matters of fact — the stimulus effect, employment, housing — etc.  These require more interpretation.  If the slam dunk facts are interpreted incorrectly, what do you think is happening on issues requiring more nuance?

Please note that this is not an endorsement of current Obama policies.  Regular readers know that I have many objections.  I evaluate policy by expected effect, no matter which party is in power.

My position is that of political agnostic, seeking profit no matter who is in power.  Meanwhile, many sources are aligned to tell you that everything is terrible.

Let us review the past week, and then return to the main theme.

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

Since it has been two weeks since my last market update I am going to reach back a little more than a week for my review.

The Good

The corporate earnings season concluded with a 65.8% beat rate (63% on revenues).  Check out the great charts from Bespoke Investment Group to see the comparisons with past years.

The Fed decision to maintain, for a time, the current size of its balance sheet.  Allowing mortgage investments to “run off” through current refinancing actions would have been a de facto monetary tightening at a bad time.  Similarly, expanding to a new program of quantitative easing does not seem warranted.  Those pundits who linked the “delayed market reaction” of the next day to a message from the Fed are overreaching for an explanation.  I do not believe in delayed reactions.  Too many are watching, and watching closely.

Industrial production was good and so was freight traffic.  See If the economic road is so bumpy, why are all those trucks on the move?

Business dynamics data show that job creation from new businesses strengthened at the end of 2009.  While these are old data, they contradict a popular perception about job creation and are a distinct improvement over the last report.  As usual, I’ll follow up on in detail on the employment picture.  No one else seems to have noticed.

Middle East peace talks.  With so many failures, can we be optimistic about a solution?  At least it is a start.  At at time when everyone notes vague “market headwinds” it seems only fair to take notice of progress.

The Bad

Initial jobless claims spiked to 500K and the four-week moving average to 483K.  This level of job loss is not consistent with strong net job growth.  Some believe that there are misleading seasonal factors at work, but it will take a dramatic change to affect the four-week average.

The Philly Fed Index plummeted into negative territory.  I do not regard this as very important since it is a small and atypical region of the country.  When the move is a big one, the market reacts.  Bill Luby (one of our featured sources) does a fine job of looking at the index components. Bill points out that there is optimism about future orders, but not so much about employment.

The ECRI index downticked again.  It really has not changed much.  The ECRI team still sees weakness but no recession call.  Others interpreting the data see a different picture.

Building permits were a little light.  Permits are an excellent read on future construction.  Economic growth from housing is still a remote prospect.

The Ugly

The market and pundit reaction has been extremely negative.  Since this is a summary of my conclusions — what I think is useful for various time frames — I am not going to argue out each point.  Some topics I have covered in the past.  Others are on the agenda.  Feel free to disagree in the comments.

The market scaremongers.  There are many highly-publicized predictions of a market crash.  There is no accountability.  There is no fact-checking or record-checking on the extremists.  Some of the warning messages “go viral.”  People want to believe the scary fantasy and they want to pass it along.  Anyone who understands the scientific method, back-fitting of data, and similar topics will easily dismiss illusions like the “Hindenburg Omen.”  Most investors lack these skills.  That is bad news for them, but good news for the astute.

The economic scaremongers.  There is a wide and obvious disparity in economic expectations.  In general — and there are a few notable exceptions — the mainstream economic community sees modest economic growth and little near-term chance of a recession.  The “pop economists” blogging on the topic are far more pessimistic.  Those who do not do formal forecasts are more pessimistic.  Those who have a political agenda are pessimistic.  Those who need blog hits (a group that distressingly now includes mainstream media) are pessimistic.

The political scaremongers.  There is a natural market for negativity.  Those out of power can and should attack, claiming nothing has worked and nothing will work.  It is great political theater.

The Week Ahead

There will be housing data and more information on jobless claims, but the focus will still be political.  We are in the dog days of summer.  Many will be on vacation and the political debate will still command attention in business stories.

Our Own Forecast

Our own indicators moved to bullish last week.  We are still cautious, with many sectors in the penalty box.  This is a recognition that we cannot make a solid prediction.  That is
the purpose of our “penalty box.”  When a sector is in the penalty box,
we know that forecasting future moves will be challenging.  Despite this, the overall rating is positive and we have a few buy signals. As a result,
the model is still bullish, and that is our vote in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see compared to two weeks ago:

  •  96% of our 55 ETF’s have a positive rating.  This is up from 86% a few weeks ago.
  • 96% of our 55 sectors are in our “penalty box,” similar to recent weeks.  This means that uncertainty remains high.
  • Our universe has a median strength of +33, up slightly from +28 two weeks ago.

We have been partly invested in various sectors over the last week, reflecting a modestly bullish position.

[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.]

Investment Implications

The confluence of negativity should be attractive for long-term investors.  Since our models also join in with a buy signal, this is a particularly good time for equity investors.

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