Weighing the Week Ahead: Will Fear Beget More Fear?
Last week I predicted that the major theme for the week would focus on whether rising interest rates would kill the stock market rally. That was reasonably accurate, since the interest rate story was on the front burner during the wild Wednesday announcement of the FOMC minutes and also in the discussion of the disappointing housing news.
On balance, stocks held up pretty well, but the narrative was quite different. I was struck by a bearish shift in tone. Since I follow a wide variety of sources from different perspectives, this surprised me. It was almost as if there was a campaign of fear – and not just from the usual suspects.
This week may see more of the same. With so many anticipating a correction, how many fingers are on the "sell" trigger?
Will fear beget fear?
Experienced investors know markets – stocks, bonds, ETFs, commodities, real estate, etc. – have periods of unusual volatility. No market moves in a straight line. This does not mean that each move can be explained and they certainly cannot be predicted. The profession of punditry requires that experts go on TV or write articles explaining why stocks moved ½%, but it is not usually taken very seriously.
Was I imagining this difference in tone? If so, I am not alone. Joe Fahmy's intriguing post, An Unusual Series of Bearish Events, describes a list of experiences – email, twitter feed, news articles – quite similar to my own and also peaking on Wednesday after the close. There is also specific data in the form of the NAAIM (active mangers) survey, which shows an astounding plunge in sentiment at mid-week. The article shows the entire data history.
Here is Joe's take:
"Although I've seen this phenomenon of extreme fear before, this series of events seemed very strange to me. Does it mean anything? I'll leave that up to you to decide. Have we bottomed yet? Not sure, but I will say that I've turned a little more bullish going into year-end. Good luck trading!"
I have my own thoughts about the fear trade which I'll report in the conclusion. First, let us do our regular update of last week's news and data.
Background on "Weighing the Week Ahead"
There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
In contrast, I highlight a smaller group of events. My theme is an expert guess about 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. Each week I consider the upcoming calendar and the current market, predicting the main theme we should expect. This step is an important part of my trading preparation and planning. It takes more hours than you can imagine.
My record is pretty good. If you review the list of titles it looks like a history of market concerns. Wrong! The thing to note is that I highlighted each topic the week before it grabbed the attention. I find it useful to reflect on the key theme for the week ahead, and I hope you will as well.
This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!
Last Week's Data
Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
- It is better than expectations.
There was some good news in a decidedly mixed week.
- Microsoft led a market rebound. The witty Eddy Elfenbein notes that if your stock gains $24 B when you quit, you probably did the right thing! (Has MSFT escaped from the "value trap" status? There are many other stocks in the same category. [long MSFT stock versus SEP 34 calls]
- Chinese manufacturing is growing (via NYT). The HSBC flash index showed an upside surprise. The "official" results are usually higher.
Copper is showing strength — including reduced inventories and Chinese demand. The Financial Post notes as follows:
"The most significant growth in demand, however, is coming from China, the world's largest consumer of commodities. Chinese officials revealed this week that net imports reached 272,390 tonnes in July, up 5.3% from June and 12.6% year-over-year."
- Jobless claims are holding at a lower level. The weekly series moved higher, but not dramatically given the seasonal fluctuation. This seems to be a new and lower level of job losses. Now we need to see more job creation.
- Jackson Hole commentary was dovish. In Bernanke's absence, interviews with others got extra publicity. Readers know that I believe this all to be exaggerated, but it did seem to have a calming effect at week's end.
- Existing home sales were solid. The problem is that these are closed contracts, not indicative of the recent rise in mortgage prices. The real key is inventory. Calculated Risk is the best source for interpreting the data and making sense of the apparent cross-currents. Think inventory! Bill's chart shows the overall improvement, but see the article and read his links for the full story.
There was a fair share of bad news.
- The Fed Minutes. I am scoring this as "bad" because the market went down a little after some wild gyrations. The DJIA was down less than 1% and it had done half of that before the FOMC report. The decline, spike back to unchanged, and selling to the lows seemed to provide credibility to a bearish spin. My personal viewpoint was that there was nothing new. Josh Brown highlights a good source who thinks the statement was dovish. The market did not agree.
- Retail earnings had another bad week. There is some variation by brand, but apparel seems especially weak.
- New home sales disappointed. Calculated Risk sees this as a (temporary) reaction to higher mortgage rates. The overall growth of new homes (as opposed to existing sales) should continue. Check out the charts and analysis. Meanwhile, the market is taking this at face value.
- The NASDAQ flash freeze. In a real sense, this had little effect. Do people really need constant access to markets? Regardless of the answer to that question, the story provided another reason to suggest that investors should not have confidence in financial institutions.
- Economic progress continues to disappoint. Research shows that Household Income has still not recovered from the recession. Doug Short does a great job of reviewing the recent data from Sentier Research. Read his posts here and here, including this chart:
Whatever progress has been made, it has not been enough.
Syria. At the time of publication, the U.S. is evaluating options for dealing with possible weapons of mass destruction in Syria. Actions might even include the use of cruise missiles. This is mostly a human story and one for debate about US policy. I deplore the cynicism of turning everything into market news, but it is still something to be noted.
My perspective is that we can and should have strong opinions as citizens, but put that aside as investors. In this second role, we must continue to monitor events.
The Indicator Snapshot
It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:
- For financial risk, the St. Louis Financial Stress Index.
- An updated analysis of recession probability from key sources.
- For market trends, the key measures from our "Felix" ETF model.
The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.
I feature the C-Score, a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.
I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.
I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration. Dwaine has also developed a market-timing approach which follows ten bear market signals. His latest installment provides detail and a current look.
Georg Vrba's four-input recession indicator is also benign. "Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon." Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals. For those interested in gold, he has a recent update, asking when there will be a fresh buy signal.
Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage
of the ECRI recession prediction, now almost two years old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.
The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.
Why hasn't the ECRI changed its tune in the face of the evidence? Doug is showing extremely great patience in his gracious, open-minded look at the evidence.
Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. Over the summer Felix has ranged from bearish to bullish, but without a strong signal either way. In two weeks we have declined dramatically in the ratings. Because I update these results weekly, some readers treat it as a prediction for the coming week. Not so. Felix has a three-week time horizon and the poll (published weekly) asks for a one-month forecast. To gauge the accuracy you need to look at a three-week outcome.
Felix does best at getting on the right side of sustained moves, enjoying most of the year's rally while others were bailing out. Felix has also done well in highlighting recent uncertainty, with high "penalty box" readings. We have adjusted this week's forecast to neutral, despite the slightly bullish readings. Some of the recommended sectors are foreign ETFs and the major index ETFs are mixed. The relatively high penalty box rating underscores the difficulty in making short-term forecasts in the current market.
[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 ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]
The Week Ahead
This week is a slow one for scheduled data and news.
The "A List" includes the following:
- Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
- Personal income and consumption (F). A key measure of the pace of the economic rebound (July data).
- Michigan sentiment index (F). This remains a good concurrent indicator for employment and spending. Will there be a rebound from the lower weak preliminary readings.
- Conference Board sentiment (T). While I prefer the Michigan approach, the Conference Board method usually has a very similar results.
The "B List" includes the following:
- Durable goods (M). Another read on GDP changes.
- Case-Shiller home prices (T). Widely followed, but slow to change and only 20 cities.
- Chicago PMI (F). This always has a special interest when the trading month ends on a Friday. It is the single best indicator for the national ISM index.
- GDP second estimate (Th). This is backward-looking, but it does show the current base.
I am not very interested in the regional Fed reports.
Talking Fed heads include Richmond Pres. Lacker (dove) who is speaking on the history of the Fed, but might say something in Q and A and St. Louis Pres. Bullard (hawk) who will address the economy. These both occur on Thursday. In a low-volume summer environment, with many already leaving for a long weekend, any piece of news might have an effect, so I'll be watching.
How to Use the Weekly Data Updates
In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a "one size fits all" approach.
To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?
My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.
Insight for Traders
Felix has continued a neutral posture, now better reflected in trading accounts which are 1/3 invested in a foreign ETF. The overall ratings are slightly negative, so we are close to an outright bearish call. This could easily be the case by the end of next week. While it is a three-week forecast, we update the model every day and trade accordingly. It is fair to say that Felix is cautious about the next few weeks. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens.
Insight for Investors
The most helpful recent article comes from Abnormal Returns. (We all benefit when Tadas takes the time to write on a general theme, in addition to his regular citation of the best links).
The concept is that market timing easily leads investors out of the market, but there is no good signal for re-entry. Cash becomes an addiction! This is an important post, which should be a jarring dose of reality for many investors who have mistimed the market. Tadas writes, "I think that "cash is a drug" for most investors. Easy to start, difficult to kick. Always a reason to NOT get back in."
This is also the message I have emphasized. Do not be seduced by the idea that you can time the market, calling every 10% correction. Many claim this ability, but few have a documented record to prove it. Most who claim past success are using a back-tested model. Please see The Seduction of Market Timing.
This is an opportunity for reflection. Think of it as a mid-year checkup.
Beware of yield plays. For several months, I have accurately emphasized the danger of yield-based investments – yesterday's source of safety. The popular name for this is "The Great Rotation." It is still in the early innings, since bond fund investors are only getting the bad news from their statements. Even the best bond managers (like Gross and Gundlach) cannot win when interest rates are rising. The exodus from their funds is starting. Most investors are emphasizing cash, real estate, and gold. .333 is good in the major leagues, but not for your investments!
It may be a "generational selling opportunity" for bonds. I locked in some positions after the recent big move, but this story is not over.
Find a safer source of yield: Take what the market is giving you!
For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. (I freely share how we do it and you can try it yourself. Follow here).
Chuck Carnevale sees some remaining opportunity in utilities. I see most of the group as over-valued and exposed to rising rates, but I always respect Chuck's analysis. Some of these might be candidates for the enhanced yield strategy.
- Lose the focus on fear! Many are rewarded for making sure that you are "scared witless" (TM OldProf euphemism). If you are addicted to gold and allegedly safe yield stocks, you need a checkup. Gold works in times of hyperinflation or deflation/crisis. When neither happens, the ball is going between these Golden Goalposts. There is a good transition plan for those with a fixation and fear and gold.
And finally, we have collected some of our recent recommendations in a new investor resource page — a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).
There is a major imbalance in market commentary.
On one side we have the following:
- Hedge funds and investment managers who are seriously trailing the market and need a decline;
- Those with a political stake in a weaker economy and a lower stock market;
- Websites that cash in on advertising page views or payments from hedge funds;
- Bond funds and the research firms that closely support them;
- TV and mass media sources that need exciting grist for page views; and
- Pundits who seek the limelight.
In sharp contrast there are sources whose own financial incentives are closely aligned with their clients. While anyone can be mistaken, Josh Brown recently explained why it can pay to be spectacularly wrong. He posted a helpful analytical matrix:
Here is a good example – and there were many from which to choose. CNBC features frequent guest Harry Dent and his prediction of a market crash to Dow 6000.
How about equal time for this analysis from Larry Swedroe at CBS MoneyWatch. After a careful analysis of Dent's horrible record, he explains as follows:
"Why do people listen to Harry Dent in light of his obvious inability to accurately predict the future? I believe it is because most of us want certainty, even when we know, logically, that it doesn't exist. With investing it is a desire to believe that there's someone who can protect us from bear markets and the devastating losses that can result. That leads to what we can call the "Wizard of Oz" effect. We come under the spell of wizards, authoritative voices who we are "trained" to take their words as truths. We want to believe that we can control things because as Woody Allen put it, otherwise "life is scarier." Yet, political scientist Philip Tetlock demonstrated in his outstanding book, "Expert Political Judgment: How Good Is It? How Can We Know?" that even professional economic forecasters don't make accurate forecasts with any persistence. In fact, the only predictor of accuracy was fame, which was negatively correlated with accuracy. In fact, those more likely feted by the media made the worst forecasts. That explains a great deal about Dent."
Sticking to the data is less exciting, but more profitable. Meanwhile, the week ahead will feature pundits trying to make much out of little.