Weighing the Week Ahead: What Should We Make of a Sputtering Economic Engine?

The economic calendar is normal but we have a holiday-shortened week. We can also expect a slow return from the weekend marking the unofficial start of summer. Despite the interesting calendar, the biggest economic news will come in two weeks. While any tweet or Pres. Trump’s visit to Japan might spark a trading move, the key question is one of analyzing recent trends. We should all be asking:

Do current trends imply a sputtering economic engine?

Last Week Recap

In last week’s installment of WTWA, I described a very light calendar with few planned events. This suggested a “quiet” week ahead. So much for that conclusion! The trade war give-and-take was not a surprise, but the gap opening on Monday came from information known the week before. Theresa May’s resignation was probably in the cards, but the timing was a surprise. I was right about an extra day off for some, since even the Pundit-in-Chief was absent.

Art Cashin opined that nothing was moving the market except trade news. Nothing from the Fed minutes or economic data seemed to matter. And who could have predicted the tweet that knocked down Jack-in-the-Box (JACK).

I am not one of Kim’s 60 million followers, but I do follow Invictus.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. This week I am featuring Investing.com’s candlestick version. Go to their site and try the interactive version which has many customization features. You can also check out the labeled news events.

The chart shows a decline of 1.2% on the week. The trading range of 4.1% is much greater than we have recently seen. A key feature is the rebound from the low on Thursday and a continuation Friday morning. That rally did not last long. Our weekly Indicator Snapshot provides a handy history of both actual and implied volatility.

Noteworthy

Graduates should not feel locked into a particular career. MarketWatch has a list of 10 versatile college majors. I agree. Hiring intelligent people who can think critically and write well is one of my rules. You can’t coach speed.

And the graduates are way ahead of most people. Consider this disturbing poll and the fact that those surveyed can vote.

The News

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!

When relevant, I include expectations (E) and the prior reading (P).

New Deal Democrat’s high frequency indicators are an important part of our regular research. In his post this week he reports an inconsistency between yield curve signals and the housing revival boost from lower interest rates. The short-term forecast is now slightly negative, but he concludes:

I continue to suspect that governmental decisions, especially mercurial tariff practices, are blindsiding a significant portion of the economy. Put another way, while I have confidence in forecasting what the economy will do if left to its own devices, it’s far from being left to its own devices at present.

The Good

  • Initial jobless claims of 211K beat expectations of 218K and seem to be holding at a good level.
  • The Chemical Activity Barometer increased 0.4% in May on a three-month moving average basis. Calculated Risk quotes the report and the leading character of this indicator. The chart shows the slowing rate of increase.

  • Mortgage applications increased 2.4%, compared to last week’s 0.6% decline.
  • Mortgage delinquencies decreased to a record low in April. (Calculated Risk).
  • New home sales for April were 673K (SAAR) beating expectations of 665K. March was upwardly revised to 723K from 692K. The upward March revision represents a new high for this cycle. Calculated Risk observes, “This comparison was the most difficult in the first half of 2018, so this is a strong start for 2019.” (emphasis in the original.) This chart from the Daily Shot illustrates the 2019 strength.

While inventory is still a little low.

  • Rail traffic while still in year-over-year contraction, is improving in Steven Hansen’s (GEI) “economically intuitive” sectors. Read the full post to see a comprehensive analysis using a variety of measures. Here is a good chart showing the contribution of intermodal traffic.

The Bad

  • Theresa May resignation may turn out in various ways, but markets hate the uncertainty. (NYT). I am watching this closely. Goldman has increased the no-deal Brexit odds.
  • Existing home sales for April registered 5.19M (SAAR), slightly lower than P of 5.21M and E 5.35M. From The Daily Shot:


  • More troops to the Middle East and also arms sales to Saudi Arabia. (NPR).
  • Durable goods orders for April declined 2.1% slightly worse than the expected -2.0%. This was much worse than March’s result of a 1.7% gain, which was downwardly revised from 2.6%. Jill Mislinski’s deep dive looks at various measures, including per capita and inflation adjustments and the use of rolling averages.


The Ugly

The federal Highway Trust Fund. Jake Varn (Bipartisan Policy Center) explains, The Highway Trust Fund Has a Numbers Problem. After 63 years, Congress may have run out of accounting gimmicks and one-time measures.

This week’s Oval Office breakdown in discussions about an infrastructure bill illustrates the depth of the problem. I explored the implications in my post, The $2 Trillion Blowup and Why It Matters. I am concerned about other crucial issues and even international relations.

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.

The Calendar

The calendar is normal and compressed into a holiday-shortened week. Personal income and spending are the featured releases. We’ll get consumer sentiment reports from both The Conference Board and the University of Michigan. The PCE price index is the Fed’s favorite measure, so I’ll be watching that. The housing data is interesting but secondary. The Q1 GDP (second estimate) seems to be far in the rear-view mirror.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

It is a time of reflection for many. There are apparent trends, but will they continue? The question of the moment:

Does the recent pattern of softer data suggest a sputtering economy?

Background

Memorial Day is a time when we all think about those who have served our country. This week was also the anniversary of my dad’s birth. A WWII veteran, he would have been 95. He was relentlessly logical and stood up for his beliefs.

Here is a brief version of a classic Miller family story. (More here, along with some practical advice).

Dad went to war instead of to college.  Growing
up in the Detroit area, he understood engines.  The principles are
simple:  Fuel, Oxygen, Ignition.  It is amazing how people can get this
wrong.

As a sailor on his first ship he found himself in an interesting
situation.  The engines had been overhauled, but would not start. 
Experienced machinists could not figure out the problem.  Officers were
hovering and complaining.  The young sailor asked if he could try
something.  There was a lot of skepticism, but he was given his
chance.  He knew that the fuel and air were OK, so he removed the spark
plug and tapped it on the deck, narrowing the gap.  When the plug was
replaced, the engines started!

If you could see a picture of the young sailor, cap tilted at a
jaunty angle, you might guess the mixed reaction.  The officers were
delighted at a problem solved.  Those in charge of the engines were
less enthusiastic.

This story was repeated many times over in his Navy career.  While
he never got all of the promotions he deserved, he was a fixture on the
boats deployed by his Captains.

Please note that others were blinded by the apparent problem, while Dad stepped away and analyzed. He relied upon first principles rather than deviant evidence. And he was not afraid to speak up.

How might we apply this lesson?

I will consider established facts, supported by data; then probabilities which involve a little forecasting; and finally, some of the more speculative implications.

Facts

  • Economic growth has slowed. Is it in second gear (MarketWatch) or on a path for a further decline. The GDP nowcasts have all weakened. Calculated Risk summarizes the latest updates and concludes that Q2 is now in the “mid 1% range.”
  • Investors are Scared Witless (OldProf Trademark Euphemism).

  • Money is flowing from stocks into bonds.

  • The impact of the trade war is more apparent and felt by more people. This real-time lesson in economics is playing out, but what will happen next?

The IMF reports that US companies are picking up the tab. (Business Insider).

  • Tariffs will eventually increase inflation.

  • Economic surprises are still negative, but less so. This is probably because expectations are lower.

Inferences

Many economic and market observers write constantly about these trends, extrapolating them without any sense of a limit. There is another group that is ready to seize upon any turning point in a data series as evidence of a complete reversal.

It is often difficult for the average investor to remember that there is some give and take in economic data. A decline from an extremely high level does not imply a complete collapse, nor even a change in the main trend. I will have more observations in today’s Final Thought.

Quant Corner and Risk Analysis

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.

Long-term technical conditions remain bullish, but the short-term technical health has declined to the neutral level.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score”.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

The expected rate of inflation is much in the news. Ignored by many, we report it because it is an important indicator of market sentiment about the economy. This chart from The Daily Shot shows the recent history.

Guest Quant Commentary

Calculated Risk has an update on his analysis of housing and recessions. Using new home sales as the key indicator, he sees no recession in sight.

James Picerno’s US Economic Profile shows the gradual decline in many indicators, but his business cycle model shows that “recession risk remains low.”

Prof. Menzie Chinn notes the possible peak in several of these indicators. “Nowcasts indicate slowing growth. Forward looking indicators look “iffy.”

Insight for Traders

Our weekly “Stock Exchange” series resumed with a crucial topic for many system traders: Is there something wrong with your method? We discussed how to know if you are Throwing in the Towel at Exactly the Wrong Time. As is our custom, we provided links to some great sources. Our model developer Vince Castelli joined in both on the main theme and the discussion of some specific actions of the models. The “V” shaped action is a difficult time for most systems, so we shared how we are handling it. There are some stock ideas. Felix ranks the Dow 30 stocks and Oscar the most liquid ETFs. Pulling it all together was our series editor, Blue Harbinger.

Insight for Investors

Investors should embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.

Best of the Week

If I had to recommend a single, must-read article for this week, it would be the fundooprofessor’s What can Long-term Value Investors Learn from Traders?
As a value investor, I look for good ideas from every source. Regular readers know that this often means a crossover between trading and investing. There are many good points, but a key is separating your behavioral tendencies from your investment decisions. There are sixteen points, but these three will illustrate the theme.

For a trader, the mindset of capital preservation first, makes him far more detached than a typical value investor who tends to fall in love with his ideas and cling to those ideas even when evidence warrants a change of mind.

But traders make far more decisions than value investors. And for them the need to change their mind in light of disconfirming evidence is far more than for long-term value investors.

It is for this reason why people who want to make living from value investing have much to learn from successful traders. Those successful traders, have had far more practice in changing their minds! And over time they become really good at it. And moreover they don’t sulk about going wrong either.

Brett Steenbarger is always at the forefront of the trader/investor intersection, and he has some practical advice about achieving the needed detachment.

Stock Ideas

Chuck Carnevale identifies a good healthcare delivery choice in AmerisourceBergen (ABC). It combines dividend growth, a “compelling valuation” and a whiff of takeover potential. Despite the negative politics surrounding health care, the fundamental drivers of the sector are intact. As always, Chuck provides a lesson in analysis along with a great stock idea.

Take some time this weekend to watch the excellent webinar from several of my colleagues at FATrader. You’ll find many good ideas along with expert reasoning for the choices. A nice feature is the ability to ask questions both during the webinar and afterward on the site. One interesting topic mentioned by multiple participants is how to identify a great CEO. Lyn Alden Schwartzer provides a helpful five-point checklist.

How will environmental issues affect big energy? The Greenpeace blockade of BP’s head office provides a hint.

Nick Maggiulli wants to Stop the Financial Pornography! I agree.

Bhavneesh Sharma continues his analysis of gene editing companies with Homology Medicines (FIXX).

Technology? John Rekenthaler (Morningstar) explains why there is no tech bubble.

Considering adding commodities as an asset class? Andy Hecht explains Why I Am A Commodity Bull.

Personal Finance

Abnormal Returns always provides interesting ideas on a wide variety of topics. I am a subscriber, and I read it daily. Each Wednesday’s edition includes a post focused on personal finance. One of Tadas’s choices was Peter Lazaroff’s Got company stock? Don’t make this common mistake. Like Peter, I have seen this several times. The danger is extreme. He writes (emphasis in the original):

The goal is to avoid having a major portion of your portfolio tied to the fortunes of any single investment.

You can either sell the bulk of your company shares immediately to get that position down well below 5%. If you’re holding those stocks in taxable accounts, you might need to space out those sales over time to help manage capital gains taxes. For investors who also have a donor-advised fund, another strategy is to donate your company shares to the fund and enjoy an immediate income tax deduction.

One method we use is the use of options to hedge the position. This must be done carefully to avoid triggering tax rules.

Gil Weinreich’s series on Seeking Alpha (SA for FA’s) is now in podcast-only mode as he accepts more responsibilities. I’ll try to listen to some of the podcasts, but it is a challenge. For me, reading is much more efficient than listening – essential when you cover as many sources as I do.

Watch out for…

  • FAANG stocks, where valuation is reverting closer to the average.

  • The five stocks most vulnerable to the Huawei blacklist. (Barron’s) And also…

  • “Overvalued cloud software” may be an example of buying the top of a trend, reports Beth Kindig.

Final Thought

We continue in a market where the daily moves are dominated by tweets and headlines. The result?

  1. Algorithms have learned key words and respond to the news or tweet language.
  2. Human traders pile on, perhaps taking the other side from the computers which are already cashing out.
  3. The punditry, charged with imposing meaning on chaos, exaggerates the effect of minor news.
  4. Mainstream media picks up these “reasons” as the story of the day, even if markets move modestly.
  5. Investors who are observing casually become unduly frightened by the scary news and volatility.

Wise investors should be using these irrational moves by Mr. Market as opportunities. There is something wrong with the engine.

My Dad would have been looking at the expected relationships. While economics is not as certain as the operation of engines, there are similarities. In general, we can expect a free-market system to make use of available capital and labor. It does not require continuing stimulus. The base case is not a recession. It is trend growth. Any evidence we see should be tested against the correct base case. So far, we see nothing that indicates a near-term recession. And productivity is improving.

This is important! Having some warning from a good recession indicator makes a massive difference in stock returns. Making a big allocation decision too soon can be expensive. It is important to avoid forecasts that are too early, without a track record, or have a lot of false positives.

If we investigate the operation of the economic engine, we should beware of excessive extrapolation, or the temptation to gain notoriety by calling a turning point. Many are doing this with the current decline in the pace of economic growth, something is quite natural given some “artificial” highs.


In fact, taking the other side of these extrapolations is the best trade. The Heisenberg suggests Bonds Could Be The Fade Of A Lifetime. Read the whole post, but here is the key point:

Hate spreads faster than love and fear sells, which helps explain why April’s “nascent reflation” narrative is seemingly dead and buried.

I agree. The current rush to bonds and bond substitutes reminds me of the 2000 era bubble.

Let’s conclude with a few more lessons from Dad.

Don’t take some long-winded analysis to be “rigorous.”  Check whether the author has the relevant expertise — research methods, economics, government, etc.

Check your sources.  It is pretty easy.  If your favorite source dishes up a constant stream of one-sided commentary, you should already know the answer.  You can enjoy reading your source for entertainment, but not for investing.

Look beyond the “talkers” and check the actual predictions.

And most importantly…

Do not conclude that someone in a uniform with braids really knows how to start the engine.

Mrs. OldProf and I wish readers a great Memorial Day celebration, filled with recognition for those who served. This includes my nephew who shares many traits with his grandfather. Both Sgt. Kyle and his wife Sgt. Jen followed Dad’s tradition with risky active duty. While their jobs are no longer active military, they continue to serve.

[If you are fixated on “headline risk or having trouble identifying your goals and the path to reach them, we can help. There is no need for “buy and hold.” We have a great program for those who need dependable income. Send an email to main at newarc dot com. We’ll provide some helpful free information, and at your option, a no-charge consultation.]

And also, some longer-term items on my radar

I’m more worried about:

  • The declining hope for compromises.
  • The growing earnings impact from the trade war.
  • Falling inflation expectations. A modest level of expected (and actual) inflation is good for many reasons, despite the omnipresent criticism from Fed bashers. James Picerno has a helpful update.

I’m less worried about

  • Recession odds. We are closely watching the yield curve and other indicators, but not yet seeing the usual confirming signals. There is also no warning from the SLFSI.
  • The likelihood and impact of Chinese US Treasury sales.

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