Weighing the Week Ahead: Understanding the Wall of Worry
One of the most difficult challenges for investors is understanding what information is already “in the market” and what constitutes fresh news. The recent market rally is a great example.
There is widespread agreement about current economic problems. Many observers express surprise that the market can rally in spite of “the fundamentals.”
This is the wrong question. The best time to invest is when things look terrible and prices reflect the poor current condidtions. I wrote an article on this topic in mid-April of 2009 that I thought was one of my best. A commenter, probably reflecting many others, offered a skeptical “Good luck with that.” It is difficult, unpopular, and profitable to have a bullish market viewpoint when the general news flow is so negative.
This concept is crucial for investors. Let us bring it up to date.
To find out what is on the minds of savvy investors, just look to Abnormal Returns. Each week Tadas posts a list of the most popular articles, a “must read” for my weekly prepration. This week two of my favorite sources provided a list of worries:
- Doug Kass is rightly worried about the decline of trust and confidence.
- Barry Ritholtz, despite a more bullish investment posture, has a list of ten worries.
Both articles are worth reading in full. There are interesting nuances and considerations, and my summary cannot possibly do justice to the entire articles.
Getting Beyond the Problems
How can stocks rally with so much to worry about? To answer this question you need to consider what these lists would have been like a month ago. Some of the worries have been crossed off! Others have been reduced.
- The crash of the Euro, the sovereign debt crisis, and the “cockroach theory” have not come to pass.
- Corporate earnings have remained strong — both current and prospective — despite skepticism.
- None of the extreme “technical” forecasts — Hindenburg Omen, head-and-shoulders top, Death Cross, or Dow Theory signals came to pass. Some are now reversing.
(We have been pretty solid on these points, predicting all three accurately in real time).
If you watch the lists of worries as they change over time, you can see that some important concerns drop off. This climbing of the “wall of worry” best explains both the current market action, and also the week ahead. Let us start with our regular review of last week.
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 emphasis on housing data. Here are the highlights.
- Market action. The reaction to mixed data was positive, and it happened at a point of technical significance.
- Durable goods, ex-transportation, showed firming in business investment.
- The ECRI indicators improved. Most people remain confused by the picture of “weaker” growth, but it is consistent with all other economic data. I am putting it in the “good” category since there is positive growth, less deceleration, and a continuing statement from the ECRI that this does not imply another imminent recession.
- Rail traffic is back to the highs for the year.
My biggest worries — factors prominently featured on the list of worries — are employment and housing.
- Initial jobless claims slipped higher. The rate is still nowhere near the level needed for sustainable job growth.
- Housing data — sales, prices, and foreclosure rates — all remain poor. I really wish that someone on the Obama policy team would think about really solving the problem instead of throwing money via “macro” approaches. One bright spot: Bonddad takes a look at permits and sees a bottom. I agree that permits are the best leading indicators. We shall see.
Some of the big stories last week did not really add anything new.
- The Fed reaffirmed existing policy with some wording tweaks. The general posture — guarding against deflation — has been frequently and clearly stated, so this was not really fresh news.
- The NBER finally decided that the recession was over — as of June 2009! This news provided a source for humor. We could all joke around and act smarter than the big-shot economists. In fact, they are simply dating the trough of the cycle, after confirming an actual rebound. These dates are interesting for research purposes, but do not coincide with popular perceptions of economic health.
The Week Ahead
The most important data will be consumer confidence and the ISM index, since these both relate to next week’s employment report. Thursday’s initial jobless claims data is important, but part of a noisy series.
Congress will break for the election recess. At this point, it seems unlikely that there will be a vote on extending the Bush tax cuts in either house. I continue to expect an extension, probably for everyone and for two years, but it may not happen until after the mid-term elections.
There will also be end-of-quarter action. Anyone with a trading viewpoint should join me in spending a few minutes each weekend with Charles Kirk’s excellent chart show (subscription only, and well worth it). This week Charles does a beautiful job with the “three scenario” problem from two weeks ago. His current take is bullish, but he also has specific ideas about the quarter end. One of the best things about his forecasts is that he tells us what to watch for as the story develops.
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 multi-week bullish posture in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:
- 95% of our 55 ETF’s have a positive rating, up from 93% last week.
- 80% of our 55 sectors are in our “penalty box,” down from 91% last week. This means that uncertainty remains high for short-term trading.
- Our universe has a median strength of +32, up slightly from +29 last week.
For trading accounts, we had full 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.]
The market moved closer to a viewpoint we have espoused for the last several weeks. It had several voices, including this one:
“The concept of a double-dip recession has been replaced with slow and steady improvement, and even if we don’t get it, we have a Federal Reserve that’s ready to step in and support the rally,” said Art Hogan, chief market analyst at Jefferies.
The futures got a big pop Friday morning after a similar statement from David Tepper. For me, this was hardly fresh news, but it is nice to see people joining in.
I continue to see a bullish environment for both traders and investors, and our accounts reflect this.