Weighing the Week Ahead: The Elusive Logic of Mr. Market
We have a very light economic calendar, and the earnings season is winding down. The punditry loves these opportunities. Rather than dealing with data, the field is open for speculation!
This has already begun. Even before results were known, every news source was speculating about events and the apparently strange behavior of financial markets. Craving simple and consistent explanations, pundits are on a quest, asking
What is the elusive logic of Mr. Market?
Last Week Summary
In my last installment of WTWA, I warned about a surge of simplistic analogies. These were market predictions based on a small number of comparisons (often just one) and frequently suggesting effects that were only one or two percent. Do we really care about seasons right now? Or what the historic post-election market results usually is?
There is a class of “research” that is reported mostly because computers have made it easy to do.
This was not a popular theme last week since there was plenty of breaking news to command attention. That said, readers should have been well prepared for a significant move — in either direction.
I always start my personal review of the week by looking at some great charts. This provides a foundation for considering news and events. Whether or not we agree with Mr. Market, it is wise to know his current mood.
This week I am featuring Jill Mislinski’s chart of the market week. Her approach combines several key variables in a single readable format.
Sector movement is another important clue to market trends.
Once again, Juan Luque provides us with some words of wisdom from the Incline trading desk:
The S&P 500 was up 7.3% this week with all sectors in positive territory. Information Technology led the way and finished up just shy of 10%. The weakest sector this week was Energy ending up 0.87% and remaining far in the lagging quadrant with no signs of recovery. The Utilities and Consumer Staples sectors, shown in blue arrows, have become very attractive. They have gained tremendous momentum and are moving strongly towards the leading quadrant. As a reminder, the sectors in blue color are often referred to as the “shopping list” by Julius de Kempenaer, inventor of the RRG.
The market gained a whopping 7.3% for the week with a trading range (not counting Monday’s gap opening) of 7.6%. Volatility is a measure of upside action as well as what happens on the downside. You can monitor volatility in my Indicator Snapshot, featured in the Quant Corner.
I enjoyed my appearance with Chuck Jaffe on Money Life. We had a good chat before the call. I did not realize that it was recorded one day and broadcast the next, thus the confusion in my mention of the date last week. Agreeing to record on election day for a show to be hear the next is a
bold dumb move, but I think I dodged the pitfalls. Chuck gets many fine guests and has an astute audience of investors with a value orientation. Many of my readers would find this to be a great source.
I look forward to a renewed emphasis on finding great investments and spotting emerging trends in markets.
The Visual Capitalist has a brief but informative analysis US government debt and why it is growing. I suggest special attention to the various categories of spending. Cuts are more difficult than they seem.
The News Overview
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!
My continuing assessment is that many of the normal economic indicators are not helpful in the wake of the COVID lockdown decline. Too many sources are focused on a change in direction, even if very modest. Looking at indicators that show the level of activity paints a different picture. Consumer spending remains high, aided by government assistance programs. Employment has improved (although less than the numbers seem to show), but those gains have stalled.
The recession has not ended nor is there an end in sight.
Public and Market Election Reaction
A close election with no clear and immediate outcome led the major concerns of most observers. High implied volatility in options markets showed that investors shared those worries.
Personally, I did not expect such reactions. More than a month ago I used WTWA to consider the election aftermath. My conclusions have not changed. Leading participants and institutions of government are following the transition norms.
No one expected a new direction from last week’s FOMC meeting or Chairman Powell’s press conference. While the Fed Chair resisted calling current programs “QE” he reaffirmed a commitment to continued aggressive action. He denied, in an answer to a question, that the Fed was out of ammunition.
Market participants seemed collectively reassured by Powell’s statement. In the past, I have suggested that the increased Fed transparency has not really been helpful. Powell has a good ear for the issues concerning his audience and answers frankly whenever possible.
- Q3 Earnings reports continued to beat expectations, sometimes at a record pace. John Butters (FactSet) writes:
86% have reported actual EPS above estimates, which is well above the five-year average of 73%. If 86% is the final percentage for the quarter, it will mark the highest percentage of S&P 500 companies reporting a positive EPS surprise since FactSet began tracking this metric in 2008. The current record is 84%, which occurred in Q2 2020. In aggregate, these companies are reporting earnings that are 19.5% above the estimates, which is also well above the five-year average of 5.6%. If 19.5% is the final percentage for the quarter, it will mark the second largest earnings surprise percentage reported by the index since FactSet began tracking this metric in 2008, trailing only the 23.1% earnings surprise percentage recorded in the previous quarter.
The results have helped to drive estimates higher, reports Brian Gilmartin who provides both data on the changes as well as his analysis. This FactSet chart shows the importance of Brian’s updates – as well as the current valuation gap.
Ed Yardeni also adds to his comprehensive analysis. Here is his chart of revenues and expectations.
I am scoring this as “bad” on balance, although some reports beat expectations. My concern about the payroll data continues. The final response rate on the second revision remains much lower than recent history. This is consistent with my hypothesis about many unrecognized extinct firms. The BLS method assumes that this is offset by new firms, and then adds a birth/death adjustment. This works most of the time, but not in a lockdown scenario. We will not find out if I am right for another three months, when we get something close to an actual count. Here is the most recent table on the indicator no one is watching.
A three percent difference may not seem like much – unless you multiply it by a 130 million workers.
New job creation as measured by private sources is not close to what has been imputed by the BLS.
- Initial jobless claims were a touch worse than expected at 751K. This was less than last week’s upwardly revised 758K but more than expectations of 735K.
- Continuing jobless claims declined to 7.285M from the prior 7.823M.
- ADP private employment for October showed an increase of 365K jobs, less than the expected 600K and worse than September’s 753K.
- Nonfarm payrolls for October increased by 638K, better than expectations of 570K but lower than September’s 672K. Private payrolls grew by 906K versus expectations of 675K.
- The unemployment rate dropped to 6.9%, better than the expected 7.7% and September’s 7.9%. But some are no longer in the labor force.
And sure enough, job hunting has declined.
Once again, there was no progress on additional assistance to offset the pandemic effects. The impact of the impasse is shown in these charts.
- Paying the rent
- Contribution to overall economic growth
- The number of US cases is increasing dramatically. Here are reports from STAT, drawing upon many solid sources.
- Deaths are also on the rise.
- Hospitalizations and deaths lead to new restrictions. Menzie Chinn explains and provides these charts.
- It all affects the economy. James Picerno explains further about the potential for new restrictions.
The daily change in US coronavirus cases shot up to nearly 122,000 yesterday (Nov. 5), a new record, based on numbers compiled by Johns Hopkins University. In several states, new restrictions have been announced or are under consideration to slow the spread of the disease. New Jersey Governor Phil Murphy, for example, says the state is “close” to rolling out new restrictions. As these restrictions are imposed (or re-imposed) around the country, the economy faces new headwinds.
Got bitcoin? To the Moon: A History of Bitcoin Price Manipulation is an academic study that shows a deviation in prices from what would be expected. And you get to review your knowledge of Benford’s law!
We can say with near 100% confidence that bitcoin’s price has been fraudulently manipulated at some point in its lifespan since 2010. We can say with 95% confidence that bitcoin was manipulated in 2013; 95% confidence that bitcoin was manipulated in 2017; and 98% confidence that bitcoin was manipulated in 2019.
We have a modest week for economic data. Inflation remains subdued so the CPI and PPI have little market effect. The JOLTS report adds nothing to the monthly employment numbers, at least in the current state of flux. Jobless claims remain the best current indicator for employment.
Briefing.com has an excellent weekly calendar and many other useful features for subscribers.
Theme and comment
Earnings season is winding down, with only fifteen S&P 500 companies scheduled to report this week. Combined with the light economic calendar, this leaves the field open for pundit speculation about financial markets.
It has already begun. Financial news features what the election means for your portfolio, even without knowing the results! There are many answers as everyone struggles with this question:
How should we interpret the elusive logic of Mr. Market?
Let us try a thought experiment. We will use the Wayback Machine on a very light setting to look back just one week. (Mrs. OldProf informed me that I had to include a link because my audience was too young to have watched the flying squirrel).
Suppose a week ago we knew everything about the upcoming election. We knew how the story played out, the challenges, the speeches, the margin of victory, and the results in various states. With all this information in hand we had to guess the market reaction.
Would anyone’s forecast have even come close to the actual rally?
Markets had gone through wild gyrations, with a week of embrace for a “blue wave” since it would increase chances for fiscal stimulus. Then a week of decline as investors supposedly reconsidered that conclusion. Why was this week different?
So many choices this week! I often recommend picking up the current issue of Barron’s, but not this week. Here are some headlines “explaining” the market rally. So many geniuses after the fact!
The Likely Power Split in Washington Suits Investors Just Fine. The article does offer some cautious notes, but doing a 180 on the blue wave.
The Stock Market Doesn’t Care Who the President Is Really? After weeks of speculating on the implications of the outcome.
How to Position Your Investment Portfolio for Transition Uncertainty and Gridlock in Government Anyone who is “positioning” for the transition is a trader, not an investor. And the level of gridlock remains unknown.
Josh Brown’s take was the best, and it was written before the election. That said, it still mis-guessed the likely implications.
If I had to pick one article for investors this week it would be Descriptions Aren’t Prescriptions from the first-rate Farnam Street blog. It will seem familiar to those who are regular readers, including this post.
Descriptions of reality are practical for helping us navigate it, while also giving us room to change things. Prescriptions are helpful for giving us ways of understanding each other and providing enough structure for shared conventions, but they can also become outdated or end up limiting flexibility. When you encounter a representation of something, it’s useful to consider which parts are descriptive and which parts are prescriptive. Remember that both prescriptions and descriptions can and should change over time.
It is easy to whip off a post stating your own opinions. Using evidence to draw fact-based conclusions is a different matter. This week invited an attack on polls from all sides, and many of my blogging colleagues obliged. This is a good subject, but for another day.
The Mind of Mr. Market
Misusing a Helpful Allegory
The challenge in identifying the logic of the market is that it does not exist!
The market consists of millions of actors with different goals, immediate needs, emotions, interpretations of facts, and reactions to current conditions. The market is the sum of these actions, weighted by size.
Usually, investors are doing nothing. Headlines that say “investors believe” or “investors are worried about” are completely bogus.
Traders are active and have a short-term focus. If there is a good trend, they want to ride it.
Investment committees re-balancing based upon valuation make large moves, but only on occasion.
Managers relying on sell side research may follow new research with abrupt, market-moving decisions. (Hint: Take a look at the institutional ownership of your stocks to gauge this effect).
What you read personifies the market for two reasons:
- People want clear and simple explanations.
- Most people relate to individual behavior rather than aggregates.
The Real Mr. Market
The real Mr. Market is an emotional, irrational aggregation of millions of people with totally different ideas. The logic is elusive because there is none. You could do better by imagining a split personality.
You can trade with Mr. Market, but you cannot really learn from him!
Applying This Insight
The best example from this week was the Fed press conference. Most observers believe that the Fed promised to support the market. Those who listened more carefully heard three important caveats:
- The Fed is not in the business of permanently financing the national debt. The current policy is a stimulative accommodation, not intended as monetization of debt.
- The Fed emphasizes the importance of help from more fiscal stimulus, noting the limits on what monetary policy can do.
- The Fed, once again, highlighted the link between the pandemic and the economy. Those who blindly rely on the Fed while ignoring the pandemic are living in a dream world.
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.
For a description of these sources, check here.
Technical measures rebounded above resistance. Will it last? Who knows?
My continued bearish posture for long-term investors is based upon both valuation and fears about the continuing recession. As always, I expect good times – but not yet.
GDP is difficult to measure and the components come in slowly. We always expect revisions. That said, it provides an important foundation for analysis. This article from Econofact shows the various choices for measuring GDP growth and the difference it makes. These same principles are valid for many other data series, so it is good to understand.
The discrepancies across the two main ways of calculating GDP growth do not reflect incorrect mathematics or the distortion of statistics, it is simply a reflection that these methods can yield different results. The differences are especially stark when the economy goes through sudden, sharp changes in GDP.
Final Thought for Investors
There is no need for speed.
- We will know much more in a short time
- Amount of cooperation during the transition
- Willingness of Sen. Majority Leader McConnell to act on a stimulus bill
- More transparency on Cabinet picks and potential policy shifts
- Development of intra-party Democratic split
- We will have much more clarity about the most promising stocks and sectors
- There will be a better chance to buy
- Economic rollover will spill into earnings expectations
- It will be easier to estimate the length of the recession
I continue to maintain higher than normal cash levels as a cushion against the continuing recession. It is possible to do this and still meet your goals provided you do not make extreme decisions. I am doing well in all stock portfolios, mostly by selecting less risky stocks.
Most important takeaway
Take a deep breath and think carefully. Big changes? Yes. It is a signal to reassess risk/reward in terms of your personal goals.
Thinking about Risk – and Future Opportunities
Take a little time to review your holdings and ask how they would do under various scenarios. My recent white paper on this topic provides a method for finding and measuring risk. It provides solid, practical information. I also urge you to join my Great Reset research group where we are discovering the best post-recession investments. I am currently focusing on REITs.
There is no charge and no obligation for either the Portfolio Risk paper or the Great Reset Group. Just make your request at my resource page.