Weighing the Week Ahead: Will There be a Signal from the Fed?
Investors continue to monitor three themes, often moving in different directions:
- The slowing rate of economic growth;
- Continuing strength in corporate earnings; and
- Confusing and contradictory technical market indicators.
Looking ahead, the Fed’s decision will be a focus of attention.
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
I’ll consider data related to each of the key themes — the economy, earnings, and the market. As usual, there is a mixed picture of good and bad.
With gains of 1.5% for the major indexes there rates to be some good news.
The earnings season showed continued strength, especially for the large-cap companies in the S&P 500. Bespoke Investment Group has the beat rate at 79%. Check out their site for comparisons, great charts, and a summary of the biggest stock reactions (more down than up).
The beat rate is even better than the typical 2-1. Did you ever notice how most people say that analysts are too optimistic in their estimates and then many also dismiss the beat rate since estimates are too low? There is a story in there somewhere!
The political front saw some improvement, with signals from the Democrats that there is room to deal on the Bush-era tax cuts. Please note that by calling this “good” I mean that it is a market-friendly development. I described my reasons and reported the results of the poll of economic bloggers in this article.
The ECRI indicators finally upticked. Their official reading is that the overall collection of their indicators does not signal a near-term recession, but that economic weakness increases the vulnerability to a shock. Mish takes issue with the past ECRI interpretations, and makes some good points. The ECRI addresses interpretations that they see as excessively bearish or bullish, nicely highlighted by Barry Ritholtz. Many others are placing their own interpretations on this indicator. Doug Short has some nice charts including some other variables.
I understand that the ECRI is trying to market a valuable service, so they need some secret sauce. I am reluctant to base my own forecasts on an index when I do not know how it is constructed. For that reason, I tend to stick with the official ECRI interpretation — at least when the statement is clear, as it is now.
Investors should also note that a recession forecast is dramatically out of consensus. Note, for example, this New York Times article featuring dueling perspectives. Even those economists who see very weak growth do not expect a recession unless there is an additional shock to the economy.
The various doomsday warnings from before my vacation did not play out as predicted. In this article, I listed some factors and asked readers to help spot anyone who had actually changed his/her opinion with the data. Thanks to those who offered comments. If you missed this piece, I am still interested in reactions.
Meanwhile, Charles Kirk is a leading trader who successfully identified a rebound while everyone else was worried. His weekly chart video (members only, but worth it) provides a good overview, plenty of ideas, and some specific advice. This week, for example, he has suggestions for those who hate the US market so much that they cannot pull the trigger, even for a short-term long trade.
The employment picture is still unacceptably weak. Friday’s employment situation report was not a surprise for my readers, since it was consistent with our other key economic indicators. The downward revisions continue to bring the data more in line with other evidence.
Menzie Chinn at Econbrowser, one of our featured sources, takes a data-based view in his article, A Sputtering Economy? He strips out the census effects in analyzing seasonally adjusted data on a log scale. I agree that it is important to look at the changes both with and without government jobs, and also on an hours worked basis. Here is one of his charts, but see the full article for a complete analysis.
The growth in jobs is not at a recession level, but it is unacceptably weak given the needs.
Let me summarize the issues:
- We need monthly net growth in payroll jobs of 150K or so just to absorb growth in the labor force. We need something like 250-300K to cut into unemployment before the next recession.
- The levels of under-employment and work force drop out are still unacceptably high, 16.5% on U-6, and possibly moving higher.
- The average duration of unemployment (despite a slight downtick) is at nearly 35 weeks, nearly twice normal levels.
- Initial claims remain persistently high, even though layoff rates have stabilized. Steve Hansen suggests that this is an indicator of low job creation.
- The churning of job creation and job loss makes the effect much broader than most people realize. I have written about this frequently, emphasizing the need for studying labor dynamics. Today’s Chicago Tribune cites the Trib/WGN poll as showing that 50% of local residents fear job loss. No wonder consumer confidence is low.
A divergent view comes from Brian Wesbury, who writes as follows:
Goods-producing industries have pushed their workweek back to pre-recession levels – meaning further production gains will translate into more employment. Meanwhile, average hourly earnings increased 0.2%. We can use data on total hours and hourly earnings to figure out total earnings, which increased at a 6.2% annual rate in July and are up at a 4.1% annual rate in the past nine months. This is more than enough for workers to both increase consumption and, if they want, increase their saving. Although the size of the labor force (workers and those who say they’re looking for work) remains stagnant, at levels first reached in early 2008, this may be related to a drop in the number of illegal immigrants, many of whom worked in residential construction, one of the sectors hit the hardest in the recession. So far this year, private payrolls are up 90,000 per month while civilian employment – minus the government sector – is up 200,000 per month.
Wesbury often has ideas not given much attention elsewhere. Even when I do not agree with a specific interpretation, I find the argument interesting.
The economic data paint a dismal picture as interpreted by the economic blogging community. Tim Kane at Growthology (now added to our featured sites) has been doing a nice series on the results from the poll of economic bloggers. Among other things, 44% expect a double-dip recession and 47% think things are worse than shown in government data. I say “Wow!” to that. Check out the site for the full summary and graphics, including an impressive word cloud from my blogging colleagues.
The Week Ahead
There is plenty of economic data for next week, but the focus will be on the FOMC decision. No one expects any move on interest rates, but there may be something about the Fed’s balance sheet. The long-running debate over reducing the balance sheet may spark attention to the commentary, as well as the usual parsing of hints about the duration of low rates.
Bob McTeer suggests that the Fed may allow mortgage securities to roll off, but not reduce the overall balance sheet size just yet. Whatever the Fed does will be interpreted as a sign of their actual read on the economy and the inflation/deflation risks. While I do not expect anything significant, it will be a carefully-watched event.
Our Own Forecast
Our own indicators have remained in a neutral mode. This helped us to avoid the recent correction, but it also missed the rebound. It is important to understand that this is just fine. It is better to recognize situations where you 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. As a result, the model is still neutral, and that is our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see compared to my last public update on July 11th:
- Only 85% of our 55 ETF’s have a positive rating and three of these are inverse ETFs. This is up from 25% a few weeks ago.
- 100% of our 55 sectors are in our “penalty box,” continuing from recent weeks.
- Our universe has a median strength of +28, up nicely from -21 in mid-July.
If current market levels hold, I expect some sector buying next 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.]