March 03, 2013

Indicator Update for February 23rd, 2013

As a small housekeeping note I am posting the Indicator Snapshot for last week. This allows a complete record of the data series.

I always plan to post the regular WTWA column, even when traveling or taking time off. Since regular business comes first, I sometimes do not have time to write. I am considering whether to invite a guest author, post an abbreviated version, or perhaps just a notice.

Here is the table from last week:

Felix was marginally bullish, and we started the week with a 2/3 long position in trading accounts.

March 03, 2013 | Permalink | Comments (0) | TrackBack (0)

February 27, 2013

Investors: How to Profit by Understanding the Fed

Why have so many TV "experts" been so wrong about the market?

Many blame government. This demonstrates that they fail to include the government factor in their forecasts.

The recessionistas asserted that economic decline was inevitable. Investors were assaulted with negative stories. This included multiple TV appearances by the ECRI and weekly columns from Hussman and Mauldin and assorted "100% recession" forecasts. It went on for more than a year. The puppet shows about the "Bernank" went viral. Meanwhile, this video (via Bonddad) has only a few thousand views.

Truth is harder to sell than fear.

How to Profit

This is a wonderful opportunity for the average investor!

Why not make objective forecasts about government policy and the likely effects? Be agnostic about partisan politics. Try to profit no matter who is in power.

The pundits make a series of mistakes, which you can easily avoid:

Underestimating government. Many have heard that George Soros "broke the pound" in his bet against the UK. Here is a clue. You are not George Soros! Governments are large and powerful and traders are small. A determined government policy will squash you like a bug. Beware.
Oversimplifying. The story is that the Fed prints money and rushes out to buy Treasury debt. The CNBC anchors ask rhetorically how much higher interest rates would be if not for the Fed. They nod wisely at each other without bothering to provide any evidence. Here are two doses of reality.
1. The entire QE program has less than a 1% effect on the ten-year note. QE3 is only a few basis points in terms of direct effect.
2. There is no direct link from QE investments (think POMO) to purchases of soybeans, oil, stocks, or anything else. If you can't trace the cash, don't risk your stash!
Poor forecasts. The average pundit thinks that the Fed may change course at any moment. The market overreacts to every dissenting speech by a Fed member. Meanwhile, the main message is clear: Expect aggressively easy money until the economy gets better. The Fed is trying to change expectations. That means you! Policy will not change because of a few strong economic reports.
Too much politics. The entire monetary policy debate was politicized during the election campaign. The "out party" will always attack – Dems in 2008 and GOP last year – but investors should see through this.
Overemphasis on stock market effects. The Fed is interested in the stock market as a measure of their effectiveness and as a (minor) economic transmission mechanism. From the Fed perspective, the more important measures are interest rates, employment, and GDP.

I do not want to turn this list into a slogan about fighting the Fed, since the story has more nuances. It is not just the Fed, but central banks around the world. And the interpretation of Fed policy cannot be done with a simplistic "risk on, risk off" approach.

Useful Background Reading

In preparing tonight's post I was looking for something original to say. I started by reviewing my past work on Fed policy and the individual investor. Many of the key points are analyzed in more detail on my investor resource page about Fed policy and QE. You can easily find the links for the last few years and check my record.

If I had to pick a single recent post, it would be my discussion of QE3 misconceptions and how to profit.

While the market is about 6% higher in the four months since I wrote that post, it is not too late. This story has many, many months to run.

One specific theme is to play stocks that are earlier in the business cycle, like Caterpillar (CAT). I also continue to favor technology names like Oracle (ORCL) and Apple (AAPL).

February 27, 2013 | Permalink | Comments (1) | TrackBack (0)

February 17, 2013

Weighing the Week Ahead: Is the Housing Rebound for Real?

Has housing bottomed? For real?

The question has special significance because the consensus economic forecast assumes improvement in this sector. This week's economic data include the most important reports on the housing market. The FOMC minutes will also provide insight into Fed policy on the purchase of mortgage securities. With Congress on an extended President's Day recess, I expect housing to be the theme of the week.

The Background Evidence

On the positive side there is the evidence of the market. The iShares Dow Jones Homebuilder Index shows the dramatic rally since June, 2012 – about 85%. The gains have been supported by commentary from executives at the major industry leaders and the top real estate publications. For many, it creates a sense of déjà vu.

Some pundits have called this quite accurately, including Schwab's Liz Ann Sonders. In an interview with TheStreet.com she opines that we are still in the first inning.

On the negative side we have Yale Professor Robert Shiller, widely acclaimed for predicting the housing bubble. Dr. Shiller is also the co-founder of a licensed home price index and also a sector based ETN using his methods.

In two recent interviews he makes the case for caution.

Housing is not a good investment vehicle, when adjusted for inflation, maintenance costs, and technology improvements. (Via Sam Ro coverage of a Trish Regan interview).
Overall optimism is too premature. In an interview with Henry Blodget at Business Insider, Dr. Shiller carefully distinguishes himself from an unnamed "perma-bear guy." Here is a key response:

Blodget: So what is your sense of the next five years? Do you think we've hit bottom in the housing market or do you have to stratify it that way?

Shiller: I think that we might have [hit bottom], but my biggest sense is that probably nothing dramatic happens either way. If the Pulsenomics survey is right, and it's up between 1 and 2 percent real, that's plausible to me. But also down 1 or 2 percent real, that's plausible. I'm sorry I don't have a more precise forecast.

Which approach is more plausible? Has housing bottomed? What does the answer mean for the individual investor? As usual, I have some thoughts on this question 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 especially like is the weekly post from the WSJ's Market Beat blog . There is a nice combination of data, speeches, and other events.

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.

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.

The Good

This was a good week, both for data and for earnings.

Retail sales were pretty good (see Steven Hansen at GEI for the full story).
Housing inventory is down 16%, y-o-y. And yet another survey shows prices higher. (Both via Calculated Risk).
Weekly jobless claims dropped to 341K, well below expectations.
There is a U.S. budget surplus! Let us not get carried away. John Lounsbury shows the reasons behind the one-month surplus, an artifact of law changes and timing. The overall deficit picture is improving, as this chart from Scott Grannis shows:

Earnings and revenue beat rates have been strong. Here at "A Dash" we report on earnings whether good or bad. Many sources always take the negative side. They suggest that earnings estimates are always too optimistic. They later say that the "bar was set too low." More recently some have argued that you must ignore earnings and look to revenue. Even by that standard the Q412 earnings season has been strong. Here is the chart from Bespoke showing the revenue beat rate. The full article has several more excellent charts and additional analysis.

M&A deals are at a new peak, healthier than those in the past, indicating solid value. Check out the powerful commentary from Josh Brown, explaining why this is the Healthiest M&A Boom in Decades.
A new source for accountability. PunditTracker lets you nominate pundits and predictions, assign grades, and follow the scores. It is a bit early to judge, but the current returns are still interesting.
Michigan sentiment posted a solid rebound. Here is my favorite chart of this indicator via Doug Short:

The Bad

There was some bad news, especially on the political front.

Industrial production declined 0.1% in January versus an expected gain of 0.2% or so. New Deal Democrat points out that the story was not all bad. There were significant revisions to the November and December reports. With the revisions included, the overall level is actually better than expected. (See also Doug Short in the indicator update below).
Earnings growth estimates seem too optimistic. Check out this chart from Eddy Elfenbein and see his analysis:

The sequester is coming. The State of the Union speech did not bridge the gap. The Democratic Senate proposal is a non-starter. No one on either side is upbeat about an eleventh-hour solution. Meanwhile, Congress voted to recess until February 25^th. But don't worry. In the wake of last week's asteroid news, House Committee hearings are already planned!
The end of the payroll tax cut is hurting retail sales. A leaked email from a Wal-Mart executive suggests that February sales are terrible. This hit both retail stocks and the overall market on Friday. Higher gas prices add to the concern.

The Ugly

Suspicious trading in Heinz options suggests that someone had advance information. A level playing field is important for investor confidence, so this deserves SEC attention. Paul Vigna's story reports how the SEC is freezing the Swiss trading accounts involved and also acting to determine who is involved.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

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 moved a lot lower, and is now 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.

The C-Score is 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. 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. I will try to do a more complete review soon. Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year 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 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.

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. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.

[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 abbreviated trading week brings some interesting data.

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. Weather effects will complicate our interpretation.
Leading economic indicators (Th). This is still a favorite for some.
Building permits (W). My favorite leading indicator for housing.
FOMC minutes (W). The market is (mistakenly) poised for any fresh news about the Fed.

The "B List" includes the following:

PPI (W). Expecting little, but important if perceived as a change in the trend.
CPI (Th). Expecting little, but important if perceived as a change in the trend.
Housing Starts (W). This is a key element of the economic rebound, so it is important to follow.
FAFA home prices (T). These are the prices from the regular homes in the government market.

It is the open period between Fed meetings, so there will be plenty of speeches, especially on Thursday.

Trading Time Frame

Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks. Felix did pretty well last year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Felix has been cautious, but still has caught most of the rally, and done so with less risk.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

Prof. James Hamilton has a great post explaining your choices: "The question is maybe not what is a good investment right now, but instead what is the least bad investment." He writes further as follows:

But what else are you going to do? Low as the dividend yield is on stocks at the moment (2.04%) , it's still better than what you can get on a 10-year U.S. Treasury bond. Moreover, any inflation in the prices of the goods and services that firms sell, as well as any profit gains associated with a larger market, should boost those dividends over time, whereas inflation would continue to erode what you make on the Treasury. Or you might look at a Treasury Inflation Protected Security, whose coupon will rise with the headline CPI. That's currently yielding a hefty -0.57%. Anybody want to sign up for that 10-year plan?

High-yield bonds are dangerous, partly because of the stampede for yield. (Formerly referred to in my series merely as the Quest for Yield). David Schawel (in an article highlighted for us all by Abnormal Returns), writes as follows:

Greater price risk now exists: The devil is always in the details, and price is an important risk that most corporate bond investors, in my opinion, are overlooking.

Gold is currently on a "sell signal" according to Georg Vrba, whose technical model follows the Coppock indicator.

The last sell signal was at the end of November 2012 and no new buy signal has so far appeared. What is needed now for an early buy signal is a sustained upward move of the gold price to over $1,700 during the next few weeks, something which is certainly not outside the bounds of probability.

Meanwhile, we have continuing "headline risk." Buying stocks in times of fear is easy to say, but so difficult to implement. The big-shot experts on TV are calling you the dumb money, even when you have been right! (in case you missed it, see this discussion).

Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out." For many, the big shift is on.

Scott Grannis provides a useful chart of fund flows and writes as follows:

This follows six years during which equity funds experienced huge and almost relentless outflows. Has the tide finally turned? Are investors now finally becoming bullish after four years of strong equity gains? Perhaps, but if this is the beginning of the return of bullish sentiment, it likely has a long way to go before it runs out of gas.

This can all seem confusing for the individual investor. To help, I have collected some of my 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).

Final Thought

Do we have a bottom in housing? This type of question is very dangerous. It raises a topic that we all think we know about and we all have an opinion. We are tempted to substitute what we see in our neighborhoods (relevant but not decisive) for actual data. Things are looking pretty good in my town, but I would like to know more. I recognize that I am not an expert on housing. I am an informed consumer of the reports of housing experts. So are you, whether you realize it or not!

When I look for expertise, I have three paramount thoughts:

Is the information something that can create value in my investments?
Does the source change conclusions with the evidence?
Are the changes timely?

I have occasionally been accused of credentialism in favor of academics and degrees. I object, since I seek the best information from all sources. Sometimes this means that I regard the world's leading experts on monetary policy at the zero bound as superior to some bloggers who are "self-taught in Austrian economics" (the most dangerous words in the investment lexicon). On this occasion I suggest that Dr. Shiller is failing on all three counts. His work is solid by academic standards, but it is much too slow to change and essentially not profitable for investors.

John Paulson was timely in spotting the housing risk. He has a new viewpoint.

Bill McBride at the Calculated Risk blog earned the respect of everyone, including leading economists. This recent feature in the Los Angeles Times tells you what you need to know.

From our perspective, he meets the key tests:

He told us that the "Housing Bottom is Here" a year ago.
He follows inventory carefully, remaining skeptical of industry sources.
He understands the big picture, showing how housing spills over into the general economy.

Investment Conclusion

The housing stocks are too rich for me, although we have sometimes held ETF positions in the Felix portfolio. My current focus is on the implication for the overall economy. The story continues to be both important and positive. Housing has been a multi-year subtraction from the economy. Even a modest rate of growth represents a major change with implications for consumers and employment. This helps to explain the spending and sentiment strength, even in the face of the payroll tax change.

February 17, 2013 in Individual Investors, Markets, The Week Ahead, Trading | Permalink | Comments (6) | TrackBack (0)

February 09, 2013

Weighing the Week Ahead: Hope for a Budget Compromise?

Sometimes the week ahead, despite our relentless focus on markets, brings policy issues to the fore. Such was the case during the fiscal cliff countdown, and it is happening again.

Here at "A Dash" I have strongly advised that investors remain agnostic about politics. It is more profitable to accept the reality of current policy. Figure out what investment is best for the times. For this reason I rarely opine about policy. I often identify what is most likely to happen, and which outcomes are market-friendly.

In this spirit I suggest that investors should be monitoring the slow and laborious process toward a compromise that will avoid the impending spending sequestration. Until now I have refrained from writing about this issue. Why this week? Two things.

It will be a light week for other economic data, leaving plenty of media space and time to fill. My mission in the WTWA series is to forecast what will be on the agenda.
The State of the Union speech might offer some real hints -- if you know what to look for.

Background on the Sequestration Issue

Sequestration was adopted originally as part of the resolution to the 2011 debt ceiling impasse. The Budget Control Act of 2011 (Congress is great at misleading names for bills!) created a Congressional Joint Committee on Deficit Reduction. This "SuperCommittee" was evenly balanced, and failed to reach a bipartisan agreement within the time limit. Congress has acted to delay the implementation of these cuts, most recently as part of the so-called "fiscal cliff" resolution. D-Day is now March 1^st, but the effects are already being felt in many ways.

While some now seem willing to allow sequestration provisions to take effect, no one really believes that the meat-axe approach is the preferred solution to U.S. budget problems. In fact, the original intent was exactly the opposite.

The issue is important. The automatic cuts will reduce expected economic growth by 0.7% according to the Congressional Budget Office. This will have a related effect on expected corporate earnings.

The timing is important, since Congress is about to go on an extended "President's Day Recess" starting Friday.

Background on the State of the Union

President Obama's second inaugural address was widely perceived as aggressive and partisan. The tradition for the State of the Union Address is different. While it lays out an agenda, it often strikes some bi-partisan and patriotic themes. It will and should be closely watched as a hint for the future. There are some preliminary leaks about the text, but even these may be trial balloons.

I have some thoughts on what to watch for in the SOTU speech which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

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.

The Good

This was a generally positive week, both for data and for earnings.

The outlook for profit margins is promising in the eyes of most analysts. Sam Ro of Business Insider show the consensus take and highlights the dissent from Goldman Sachs. Even that viewpoint is better than the common bearish assumptions of rapid mean reversion. Here is the key chart:

Nouriel Roubini is "optimistic" on stocks. (via John Sullivan at AdvisorOne). We always admire those who use facts, changing forecasts as indicated. For those who will call this a contrary indicator, you need a reality check. That interpretation guarantees that you will never change your mind.
The trade deficit improved – a lot! This certainly flips the sign on the preliminary Q412 GDP report, and may represent an increase of as much as 0.7% Contrary opinion from Steven Hansen. Here is a helpful chart from Calculated Risk:

Home prices are up 8.3% year-over-year. The CoreLogic data is reported by everyone's go-to source on housing, Calculated Risk.

The earnings beat rate is still strong. Revenues, too. Despite the twist you might have seen from your favorite conspiracy site, Bespoke has the real story, with the expected great charts:

So far this earnings season, 64% of US companies that have reported earnings have beaten earnings estimates, while 63% of companies have beaten revenue estimates. As we highlighted last Friday, both of these readings are strong compared to past quarters over the last few years.

The Bad

There was some bad news, but not so much on economic data. Feel free to add in the comments anything you think I missed!

Insiders are selling – big time! Mark Hulbert says that the pace is the fastest in several years. Cam Hui emphasizes the warning, pointing out that potential tax selling is no longer an excuse. Guy Ortmann of Scarsdale Equities also hit this theme in his excellent daily commentary. "…(T)he sentiment indicators are flashing very red warning lights as follows. The Rydex Ratio (contrary indicator) is now at a 10 year high of 48.8 showing the leveraged ETF traders as more bullish than at any point in the last decade. We would note that at the market lows in mid-November they were at a bearish extreme not seen since February 2009. Sell low, buy high??
Gas prices are up. It is the biggest share of pre-tax income in decades, about 4%. (via The Hill's Energy Blog). Sober Look sees a possible effect on consumer sentiment and spending and provides this chart of the front-month futures:

Factory orders were a little light.
Productivity is lower, implying slower growth. (Via Scott Grannis). Alternate view from Steven Hansen of GEI.
Initial jobless claims moved higher. So much for the 300K range. Bespoke has a good chart with helpful notes:

The Ugly

The Wall Street Journal reporters have been urged to do shorter and funnier articles. I know the feeling! Mrs. OldProf, looking up from her book, just asked me about the length and humor quotient of today's piece. I admitted that it was long and laden with lessons about Ben Franklin, compromise, and what really will matter to our investments.

She recommended that I find something to spice it up a bit. The big-time bloggers all write about cars and music and such. Good advice! We all know that on Wall Street if you want a friend you should get a dog. Here is her suggestion for your next dog. It brought a smile to my face.

Recommended Reading

Abnormal Returns points to the Credit Suisse Global Investment Returns Yearbook. Tadas starts with an intriguing chart. The Yearbook explains that one and more. This is worth some time to study.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data were expensive for many. The reason that I track this weekly 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.

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. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. The low current rating means that few ETFs are in the penalty box, so we have more confidence in the overall ratings.

The Week Ahead

This week is extremely light on economic data.

The "A List" includes the following:

Michigan Consumer Sentiment (F). More important than usual because of the recent dip, fuel prices, and the payroll tax increase.
Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.

The "B List" includes the following:

Retail Sales (W). Holiday season is significant. Confirmation of same-store sales?
JOLTs Report (T). No one seems to do a really good job with this, since they try to infer overall employment. It is more about structure.
Industrial Production (F). This is an element of GDP, so it will be watched closely.

The State of the Union on Tuesday night will be the big story of the week.

There will be Fed speeches almost every day. These are not really relevant given the Fed guidance, but that will not stop the pundits.

Earnings stories are winding down, but still noteworthy.

Trading Time Frame

Felix has continued a bullish posture. Felix did pretty well last year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Felix has been cautious, but still has caught most of the rally, and done so with less risk. Felix has been bullish in 2013, but the ratings have been declining a little.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

The current investment climate offers a dearth of choices!

Greater price risk now exists: The devil is always in the details, and price is an important risk that most corporate bond investors, in my opinion, are overlooking.

Gold is currently on a "sell signal" according to Georg Vrba, whose technical model follows the Coppock indicator.

There are some alternatives, but the answer is different for each investor. 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).

Final Thought

Is there realistic hope for a budget compromise?

Most of the pundits you see or read have little understanding of history, Congress, or the policy-making process. For them the answers are easy and obvious. Anyone who does not agree is a fool.

I am currently spending my leisure time reading Walter Isaacson's wonderful biography of Ben Franklin. As I read the final chapters on the Constitutional Convention I am struck by two themes related to compromise:

The U.S. Constitution required serious compromise of strongly-held principles by all parties. Franklin was not a great orator, but his final speech to the convention is widely acclaimed as stimulating the needed support for this new government.
The resulting government implemented checks and balances that would make compromise the order of the day for progress.

If you do not understand this, you will never be able to see how government decisions affect your investments.

Senate Democrats are vague but hopeful in their comments. Obama has earlier stated that the sequestration cuts would not occur. I will be closely watching Tuesday's speech for signs of flexibility and bi-partisanship.

Investment Conclusion

I anticipate plenty of SOTU discussion on Wednesday. The challenge will be to sift through the partisan commentary.

Avoiding sequestration would be bullish for the overall market. My guess – and that is all that anyone can do right now – is that observers see this as a 50-50 proposition or worse.

Specific sectors that would be helped relate primarily to defense stocks, a group that I'll be watching closely. (NOC, LMT, and RTN, are candidates).

[Currently long hedged positions in NOC and RTN for some accounts.]

February 09, 2013 in Government, Individual Investors, Markets, The Week Ahead, Trading | Permalink | Comments (5) | TrackBack (0)

February 05, 2013

Dumb Money?

Are you part of the "dumb money?"

Here is a helpful guide:

Amateur vs. smart money

What the experts are seeing is that retail investors are slamming money into mutual funds, which then buy stocks, of course, but then there are signs that the smarties — institutional investors — are getting more cautious and looking to increase cash holdings.

That said, the outflows to cash are not all that big right now but it has to be said this dumb (or amateur money) in versus smart money out trend happened last year ahead of a stock sell-off in April. And those bad times for stocks lasted until October.

CNBC says corporate insiders are also heading out of shares. Jeff Cox pointed out that "they've dumped $4.2 billion in stock this month, about double January's level and — here's that warning sign again — the most since … last year's rally fizzled, according to TrimTabs".

And here is more from Jeff Cox of CNBC via the online transcript with errors included. You can figure it out. And check the link for Bob Pisani's rebuttal. (video here):

…(L)ook at the money coming into the market now. it's late money. the big selling point for this real has been this fun flows metric. i did szott some tracing back. i went back to 2007. in fact, 2008 was the only year, the only january that we have not seen a big in flow into funds so you can't tell a whole lot about that. you look at what the insiders are doing. that's what i'm doing right now. the corporations have stopped buying. the unsiders are selling, so this is telling you that this rally is getting very tired, and i do believe this dash for trash that i call it, the big stocks, the big metrix doing well, stocks with a lot of short interest and zero dividend payers. they have led the rally. sorry to use the word dumb money but it doesn't look smart to me right now. a dumb idea to put money to work in this market? the corporate insiders, they are sellers.

The two statements from Cox are quite similar. The only change is that the second does not refer to institutional investors but to corporations. That would be easy to miss.

Now think about this:

The market changes, but the Jeff Cox story does not. He seems to be a designated hitter for a bearish viewpoint.

The first statement was from February of 2012, one year and almost eleven percent ago. Cox's story has changed in one respect. The new statement does not cite the big money investors, because their attitude is much more bullish. He is not calling them "dumb money." CNBC's own Davos series and the Barron's roundtable have highlighted that many big-name, high-profile investors see great upside for stocks. One example, also from CNBC, is Ron Baron who provides the logic for Dow 30K.

In a further explanation of his investment philosophy, Baron said, "Over the long term, I think the stock market is going to grow 7 percent a year," about the same rate as the overall economy, not adjusting for inflation. He said that this has been the norm for generations and he doesn't see that changing.

"So people are saying … '[Dow] 14,000, is it too late?' It's not too late; 14,000, I'm thinking in 10 years, it's going to be 30,000. In 20 years, it's going to be 50,000 or 60,000."

It makes the OldProf feel like a piker. Back in May of 2010, when the Dow was at 10,000 and there were predictions of 5000, I wrote the following:

Someone needs to say this:

Dow 20K.

The fear mongers abound in the financial media. TV and online ratings seem to go to those helping to peddle fear and sell gold or structured annuities (with high commissions attached). Every individual investor I meet is scared silly. They do not realize what is at stake.

For the mainstream media, it is all about ratings. They have all learned that fear sells. Attacking Obama, attacking Bernanke, attacking European leaders, explaining government policy as if it were the family budget --- it all works. The big-time media have garnered page views and sold papers.

Even when they attempt to show "balance" they have someone warning about Dow 5000 and the "bull" saying that stocks will go up 8% this year! Is it any surprise that watchers are scared witless?

Investors need to understand that they are missing more than an 8% move. Stocks will double. When will they get on board? Do they have a plan?

I hope that everyone has noticed how the words from nearly three years ago still resound today. The same peddlers of fear and gold. The same Obama/Bernanke/family budget stuff.

Those who stayed on the sidelines have missed the first 40%. Some assert that the market is now "giddy" and stocks are "toppy."

Just think about that reasoning. A rising market makes new highs. If you are going to define every new high as "toppy" you will never buy stocks. As I asked three years ago, "What is the plan?"

Objective Analysis

The best way to invest is through data-driven, objective measures. When I analyze a stock, I look at the future expected earnings and cash flow, adjusted for business circumstances and risk. I look at the business cycle. I do the same thing for the overall market – as a background for specific investments.

Since everyone is citing the prior Dow 14,000 as the key point (I don't agree about the significance, but let us join the discussion) let us compare the 2007 decline from that point to the current rally (data from Friday).

	10/12/2007	2/1/2013
S&P 500	1561.8	1513.17
Forward Earnings	94.88	113.16
Forward Yield	6.08%	7.48%
Interest Rates	4.70%	2.04%
Risk Premium	1.38%	5.44%
Risk - SLFSI	-0.186	-0.536
Dieli Indicator	91	841
Dieli Recession Odds Interpretation	Recession Watch 100%	9-month Recession Probability < 5%

Sources: Thomson/Reuters, St. Louis Fed, No Spin Forecast
Analysis by NewArc Investments, Inc.

Even a cursory examination of the data shows that the market is much, much more attractive than it was in 2007 – even though that story had but one flaw.

Earnings expectations are much better. You are invited to look at my last comparison of this type, where I explain why this method is better than the alternatives.

The interest rate alternative investment is pretty lame. Those whose methods ignore the asset allocation alternatives as a method are now screaming that it is all unfair.

The financial risk is very low, the objective indicator for Europe. Any investor following this indicator would have known to ignore the headline risk about Europe.

And most importantly – the recession odds. This was the key problem in 2007. Bob Dieli's indicator had all of his clients on warning. (I wish I had been one of them!) The current story is much different.

Investment Conclusion

Individual investors are fearful at the bottom, slow to spot new trends, and called stupid whenever they climb aboard. There is no objective plan for market timing, and they have all been told that "buy and hold" is wrong.

This is why I recommend the following:

Use data to adjust your viewpoint – not just absolute price.
Actively manage your portfolio, looking for the best stocks and themes.
Revise price targets regularly.

Ignore those who have been completely wrong, and who now call successful investors "dumb money."

February 05, 2013 in Contrarian Investing, Individual Investors, Market Valuation | Permalink | Comments (4) | TrackBack (0)

February 02, 2013

Weighing the Week Ahead: Market Correction Coming?

Whenever there is a big market move – in either direction – the question arises: Is it too much, too soon? I predicted that this week's focus would be on whether it was time for the individual investor to return to stocks. That was a good forecast ---for about two days!

The media tilt ensued very quickly. Since consumers of financial media are looking for actionable advice, the sources have a tilt toward trading. We all know that markets do not move in a straight line, so any significant move brings out those planning to "sell the rips and buy the dips."

Here are three interesting perspectives:

Correction Ahead

Some of the calls for a correction even emphasize the recent shift in fund flows, reflecting the change in attitude by some individual investors. Here is an example from BofA Merrill Lynch strategist Michael Hartnett, reported by Matthew Boesler of Business Insider.

For Hartnett, this implies a possible correction of 5% over a month or so. The article cites similar forecasts from other Street analysts.

Probable New Highs

Charles Kirk has, as usual, a balanced viewpoint in his weekly chart show. While noting the potential for a correction, Charles expects a test of the old highs first, possibly followed by a completion of the current bullish chart setup. My brief summary is but a shadow of what you get from the weekly chart show. (The Kirk Report requires a small membership charge, and is well worth it).

A Longer View

Taking a longer view, Josh Brown has an excellent post, Ray Dalio Schools You on the Great Rotation Debate. This must-read article explains why the current inflows to stock funds are not merely from bonds and not just from individual investors. Josh has taken the key points from a Dalio interview, helping his readers to see what is really important.

Naturally, I have my own thoughts on this topic and I'll cover those 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 especially like is the weekly post from the WSJ's Market Beat blog . There is a nice combination of data, speeches, and other events.

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.

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.

The Good

This was another good week, both for data and for earnings. The most important reports were positive.

Year-over-year growth in forward earnings – confirming the trough in Q3 of 2012. Even CNBC got on this theme last week, belatedly following the on-target commentary from Brian Gilmartin. Brian notes that the estimates are still declining a bit, but reflect an increase of nearly 6% over last year. Read the full report for plenty of detail and interpretation that you will not see elsewhere.
Q4 earnings reports continue to beat on both the top and bottom lines. Bespoke has their typically fine charts, including this one on revenue:

China is looking better. Or is it? We have been following the dueling PMI indicators for months, with Markit's version usually more pessimistic than the "official" version. Now this has reversed. I am scoring this in favor of Markit, but there is a great analysis by Kate Mackenzie at FT Alphaville and also good commentary at GEI.
Employment continues to improve, especially when you consider the final revised data. See Phil Izzo's excellent summary of economic opinion. In my monthly preview I explained why you need to look at the final results from state employment data, not just the preliminary estimates. We all know that employment gains trail what is needed for a robust recovery, but there is progress.
The ISM index notched a significant upside surprise, with solid contributions from the various subcategories. The 53.1 reading is consistent with real GDP growth of 3.4%, according to their research.
Housing data showed another week of improvement including both construction and Case-Shiller home prices. See Calculated Risk for both themes. The Case-Shiller approach has a three-month average that is not seasonally adjusted. The Calculated Risk chart makes it easier to see the current trend.

The Bad

There was plenty of data, and some of it was negative.

Initial jobless claims rebounded to 368K after two weeks of dramatic improvement. It is a challenging time for seasonal adjustments.
Conference Board consumer confidence disappointed at 58.6, down from 66.7 last month. This corresponded to the mid-month decline in the Michigan index. Payroll tax effects?
The spike in personal income was deceptive according to Dwaine Van Vuuren's analysis. He expects January to decline, reflecting the pulling forward of income because of fiscal cliff fears. Dwaine pays special attention to this indicator since it is part of his NBER recession model (details here).
Gasoline prices moved higher, continuing the recent trend (via GEI).

Europe's problems continue. FT.com notes the increase in European business confidence. The Bonddad Blog says that Europe is "Still a Mess" and provides a chart as evidence:

Employees were surprised by the payroll tax increase. Anecdotal evidence from Tim Duy.
Q4 GDP had a negative print of -0.1% in the advance estimate. Doug Short and Steven Hansen of Global Economic Intersection call this a "nasty surprise" and provide plenty of charts and data to show some historical perspective. Many felt that the data included a convergence of "one-off" effects and the market shrugged off the news. See (MarketWatch for a summary of points and Econbrowser for Prof. Hamilton's take and more links). Scott Grannis shows why the current economic growth is not enough.

The Ugly

The government threatens our personal rights according to a majority polled by Pew Research. This is a dramatic increase from a decade ago. Most people do not realize how important this is. The U.S. government depends upon confidence and trust, typically most evident among the best educated and most successful citizens. What has happened, and what will be the consequences?

Global Economic Intersection has a good account. Here is one of the charts:

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

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. I will try to do a more complete review soon. Dwaine Van Vuuren also recently published an excellent data update, demonstrating how the coincident data have reduced recession prospects.

New Deal Democrat at the Bonddad Blog has been a bulldog on tracking the ECRI forecast, including the many changing claims. His latest post refutes the most recent ECRI "telltale charts." The ECRI seems to have responded, but only to their subscribers. Eventually we might learn what they said.

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 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.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

The Week Ahead

This week is rather light on data, after last week's deluge. The calendar quirks can do this.

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. Seasonal adjustments have made the results difficult to interpret.
Trade balance (F). Especially after the GDP report we are interested in both exports and imports, as well as the balance. This report is growing in significance.

The "B List" includes the following:

Factory orders (M). Too much of a backward look to be a top indicator, but still relevant.
ISM Services (T). Services are bigger than manufacturing, but this series does not have the history of the more famous index.

It is still the heart of earnings season. These reports will be more important than ever in the absence of major economic news.

Since the FOMC meeting is over (with little excitement), we will have another round of speeches from various Fed participants. I am not expecting much, but traders will be alert for any hints of dissent.

Trading Time Frame

Felix has continued a bullish posture, fully reflected in trading accounts. Felix did pretty well last year, becoming more aggressive in a timely fashion, near the start of the summer rally, and getting out a couple of months ago. Felix got back into the market in a timely fashion. Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral. Felix has been cautious, but still has caught most of the rallies, and done so with less risk.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

Buying in times of fear is easy to say, but so difficult to implement. Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

The year is starting much as I predicted in my 2013 preview for Seeking Alpha. This article covers key investor catalysts, as well as some specific stock and sector ideas. My recommendations did well last year, and we are off to another good start. You need to be comfortable in taking the other side of one of the most hated rallies in history.

But please beware! General ideas are not for everyone. Each person needs unique treatment. We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options.

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).

Final Thoughts

Is there a looming correction? I have four very different thoughts.

People are always trying to predict the next short-term market move. While someone is always right, the allegedly great records are either back-tested or focus on a few highlighted calls. Before falling for this I urge readers to check out my post, The Seduction of Market Timing.
The fund flow shift has merely started! Those claiming that the individual investor is buying the market top need to look more carefully at the data. We have had nearly $400 billion in outflows from stock funds during the current bull market. The reverse shift so far is less than $20 billion. It is too soon to call this "dumb money."
Felix is still positive. It is true that our Felix model does not try to predict corrections, but he is not far behind when things change. Markets that are theoretically overbought can stay that way for some time. There are a few pundits and managers who have been predicting a correction constantly for several years.
The facts have changed. It was only a month ago that many (most?) thought we would go over the fiscal cliff, leading to a recession and a crash in corporate earnings. They also thought that the U.S. might default on debt. These things did not happen, nor did we enter a year-end recession. Isn't that worth six percent or so in market value?

Those who set their 2013 price targets before the year-end news need to take a fresh look at the evidence!

And finally, I am sure that there will be a correction during 2013, since there nearly always is – even during the best years. This is part of my message to every new client. For your long-term investments it is important to "right size" your position. If you are "too big," you will get nervous and bail out when the inevitable and normal correction comes.

February 02, 2013 in Individual Investors, Interpreting Data, The Week Ahead, Trading | Permalink | Comments (2) | TrackBack (0)

January 31, 2013

January Employment Report Preview

For many years I have written a regular monthly preview of the Employment Situation Report. I have done extensive research on all of the methods and even visited the stat guys at the BLS to discuss their approach.

My preview gives appropriate respect to the BLS, but also to the leading alternative methods. My best analogy was to a bean-counting contest. The winner was NOT the contestant who was closest to the correct answer. Instead, the winner had to predict the guess of a fellow contestant.

This is what we do every month. We want to know the truth about the economy. Instead of recognizing that there are several good estimates, everyone tries to guess what the BLS will report.

Please read the September preview both for a laugh and a deeper look.

This month I will also do something special. In addition to tips on what to watch for, I will look back at the most recent period for which we have actual data and see who had the best estimate!

Background

We rely too much on the monthly employment report. It is a natural mistake. We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets. Whenever there is an important question, we all seize on any available information. While we might know the limitations of the data, any concern is briefly acknowledged -- if at all -- and then swiftly put aside.

The Data

We would like to know the net addition of jobs in the month of November.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
The report is revised to reflect additional responses over the next two months. This is especially important this month since the official survey response date has been moved forward by a week. This is a routine adjustment for the Thanksgiving holiday, but it increases the potential for error and later revision.
There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone. Everyone focuses on the birth/death adjustment. This actually accounts for less than 20% of the BLS attempt to estimate job creation.
The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low, as revealed in the most recent report. For the year ending in March, 2012, the BLS estimate was off by about 30K jobs per month overall, and 35k jobs per month on private employment. The January report will incorporate these benchmark revisions.

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. The BLS is actually like one of the contestants, with the full report coming later. The market uses this estimate as "official" and declares winners and losers on that basis. No one pays any attention to the final data, which we do not see for eight months or so.

ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 192K private jobs on a seasonally adjusted basis. In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate. In recent months ADP is using an improved methodology with a stronger sample. The objective is to improve the correlation with the final print of the employment data.
TrimTabs looks at income tax withholding data. Their idea is that this is the best current method for determining real job growth. TrimTabs is forecasting a range of 135- 155K. There was a lot of year-end uncertainty about tax law from the fiscal cliff debate. TrimTabs has wisely taken note of this and reflected the potential effect.
Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).
Jeff Method. I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines. The recent uptick in consumer confidence, despite gas prices, the fiscal cliff, and Europe, is encouraging for jobs. It remains difficult to account for the effect of headlines about Europe and the fiscal cliff. The model inputs have improved a lot. The layoffs catch the headlines, because these are big visible chunks of jobs. I do not think we have a good grasp on job creation. The BLS tries hard, but their approach lags on this front. Street estimates are generally similar to my method, but few reveal much about the specific approach. These estimates usually adjust for the ADP report.
Briefing.com cites the consensus estimate as 180K, while their own forecast is for 195K. Their private jobs forecast is about 15-20K higher, since the loss of public jobs is a continuing drag.
Gallup sees unemployment as essentially unchanged at 7.8% on a non-seasonally adjusted basis. This is interesting since they have a different survey from the government, a relatively new approach to seasonal adjustment, and an extremely bearish and political approach in past commentaries. Gallup's methods deserve respect, so I am watching closely. On a seasonally adjusted basis, their unemployment rate is only 7.3%!

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

Focus on net job creation. This is the most important. The big story is the teeming stew of job gains and losses. It is never mentioned on employment Friday. The US economy creates over 7 million jobs every quarter.
Failure to recognize sampling error. The payroll number has a confidence interval of +/- 105K jobs. The household survey is +/- 450K jobs. We take small deviations from expectations too seriously -- far too seriously.
False emphasis on "the internals." Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy. In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
Negative spin on the BLS methods. There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment. This is a propaganda war that seems to have ended years ago with a huge bearish spin. For anyone who really wants to know, the BLS methods have been under-estimating new job creation. This will be reflected in the January report, which will show over 350K additional jobs in the benchmark year.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

And most importantly, it would be helpful if anyone would realize that the BLS is just one estimate among others -- and perhaps not the best. The bean counter example illustrates this.

Keeping Score and Taking Names

The authoritative scorekeeper is the Business Dynamics Series. This reflects data from state employment offices, so it is an actual count, not a statistical estimate. For the breathless market observers this comes far too late, since it takes about eight months to get the data.

Fair enough. We can still use the information to figure out who made the best predictions at that time. Here we go!

We know from the business dynamics report that in Q212 there were 1.26 million jobs created at new businesses. The reason you do not know that is because it is not reported in the financial media. They focus on the estimates of net job creation, not the actual count of new job creation. It makes a difference.

We also know that the net new private job creation was 582K. How did our contestants do? Here is a summary of the quarterly forecast from each:

	Original Employment Estimates - Q2 2012
	*ADP*	*TrimTabs*	*Briefing.com*	*BLS*
Apr-12	170000	116000	215000	115000
May-12	133000	124000	150000	69000
Jun-12	176000	75000	100000	80000
Total	479000	315000	465000	264000

Key takeaways?

All of the estimates were too low.

The much-maligned ADP was the best, and that missed by more than 100K jobs.
The BLS methods were the worst.

Trading Implications

This week's employment situation report involves special risk. The results are being teed up for a failure.

Since the preliminary Q4 GDP report had a negative print, there is a quest for confirmation. Maria Bartiromo's script seems to require the word "disaster" whenever she mentions the Q4 GDP report. If tomorrow's payroll number is weak, we can expect the recessionistas to be out in force!

Here are some fearless forecasts from the Old Prof:

Multiple pundits will jump on the benchmark revisions and ask how the BLS "found" another 350K jobs. If you look back at the history of their punditry, these will be the same people who claimed that the BLS was over-stating job growth. They do no review of their own claims.
Much will be made of seasonal adjustments - - mostly by those who have never produced a dataset that included any seasonal adjusting!
No one will recognize that the BLS estimate is just that --- an estimate. We already know most of the answer, and it is pretty good.
Any extreme result will get an exaggerated interpretation. If the job growth were to be 50K, we will have claims that recession is upon us. If the BLS estimate is 300K, we will hear that the Fed is about to tighten rates!

As usual, the number is less important than everyone thinks. So here is the most important point:

The Fed is not doing anything differently based upon the January employment report. Everything that I have written here is completely understood by the FOMC. It will take a series of results to influence Fed policy.

January 31, 2013 in Individual Investors, Interpreting Data, Markets, Trading | Permalink | Comments (0) | TrackBack (0)

January 29, 2013

The Most Common Error in Stock Market Research

There is a very common research mistake. It is pervasive in Wall Street research, even that presented by the big-name firms. My academic friends are not immune, partly because they have their own set of incentives.

My mission in this post is fourfold:

Explain the problem in a way that it can be readily understood;
Show how you can spot it in practice;
Provide a clear example;
Suggest some other applications.

The Problem – Selecting the Right Data

If you take a course in research design, one of the first topics will be determining the right data and sources for your analysis. To help us stay open-minded, I will use one of my favorite approaches – a sports analogy.

Let us suppose that we wanted to predict the total points that would be scored in tonight's basketball game between Wisconsin and (The) Ohio State University. The game is being played as I write this, so the exercise is purely academic. Here are some possible choices for our analysis:

Take the entire history of college basketball and use the average as our forecast.
Use data only from the time since the shot clock was put in place.
Use data only since the three-point basket was introduced.
Use only data from the Big Ten, which might differ from other conferences.
Use data only from Ohio State and Wisconsin, who might have different team tendencies.
Use data only from these teams in the last few years, perhaps reflecting their current personnel.

Note that the data becomes more relevant as it gets more specific. Please also note that there is still plenty of data for our problem, since college teams play 30 or so games each year. Even a few years of data would provide 100 cases.

The Stock Market Comparison

Let us take what we learned in step one and consider how it applies to the stock market. Suppose that we wanted to forecast tomorrow's trading volume at the NYSE. Here are just a few of the major changes in stock trading (readers are invited to add more) since the 1792 agreement signed under a Buttonwood Tree.

Stock quotes replaced a ticker tape.
Securities regulation to provide information.
Competitive commissions.
The invention of computers.
Options trading.
Futures trading and arbitrage.
Online trading.
New NASDAQ rules and deep pools.
Decimalization of stock prices.
SOX and regulation FD.
High frequency trading.
Individual stock circuit breakers.

There are other elements, including the more active role of the Fed, but you get the drift. If you were interested in predicting volume, you probably would not use data that was more than a few years old. Too much has changed.

Even when it comes to more general market analysis I am not interested in what happened in the Taft Administration, the FDR era, or even the Ike years. I do not care much about the Nixon years, or even Jimmy Carter. We at least need to get to the modern era of an active Fed, active stock trading with low commissions, and broader access to data through financial television and computers.

An Example

For the purposes of this post I want to use a very innocent example from two of my favorite sources – both valuable contributors to our understanding of markets and current issues.

Let us first look at this chart from my friend Doug Short:

This is a beautiful chart. It is accurate and provides the most comprehensive history available from any source. Doug notes that the long-term, inflation-adjusted increase in stock prices is an annualized growth of 1.73% and that current values are 48% above this trend.

When I look at Doug's chart my eye does not follow his proposed regression line, mostly because I am totally uninterested in the old data. I imagine a different line, starting with the post-war period – surely more relevant. I also imagine a line beginning in 1982, where the data become even more relevant.

The starting point of 1871 is represented not because it is best, but because that was the earliest year for which Dr. Shiller could generate data. There is not a strong research reason for the choice.

While I was pondering this question and considering developing my own chart, I discovered this presentation from Scott Grannis:

Scott's chart is not inflation-adjusted, but it also does not include dividends. The conclusion is dramatically different, showing that stocks are in the middle of the long-term trend – growing at almost 7% a year plus dividends.

Neither source gives any particular reason for the choice of starting point – and that is my main focus here.

Great analysis begins with choosing the right data. Everyone has heard the expression "Garbage in, garbage out." This is where it starts.

Other Applications

If you understand this problem, you have jumped the first (and most important hurdle) in identifying strong research.

It will help you grasp the mistakes of most recession and business cycle forecasters. They simply do not have enough relevant cases to do a good job of ex-post analysis.

You can see the mistakes of those whose research identifies "bad times to invest." They also do not have enough past cases, so the inferences are unsound.

You can see the shortcomings of leading academics. They get respect for exhaustive and thorough analysis, finding data that others have missed. That is fine for their book reviews. You and I need to apply a higher (different?) standard. The popular book about why "this time is different" book has only a handful of truly relevant cases.

Investment Implication

The world wants "actionable investment advice." Fair enough. I have been acting on the principle described here for several years – with weekly articles to explain.

The basic conclusion is that many of the popular pundits, despite their apparent use of data, have developed inaccurate and over-fit models. It is better to have simple models with more relevant data. These may not seem as impressive at first glance, but prove to be more robust in practice.

More to come on this important theme…..

January 29, 2013 in Forecasting, Individual Investors, Interpreting Data, Markets | Permalink | Comments (9) | TrackBack (0)

January 28, 2013

Weighing the Week Ahead: Will the Average Investor Take the Plunge?

Is it time for the individual investor to return to stocks, reversing the flows from equities to bond funds? The individual investor is usually the last to the party. What should we make of some nascent signs of a change in investing trends.

The week ahead promises an avalanche of information. We have plenty of economic data, including many of the most important reports. It is the heart of the earnings season. And finally, there are signs of a change in investor psychology.

Goldman Sachs President Gary Cohn has joined the bullish camp:

Cohn contrasted his view on stocks with that on bonds.

"Fixed income on the other hand, interesting," Cohn said. "At some point, interest rates will go higher again, and all of the money that has piled into fixed income over the past three years, some of it will come out."

Could this be a tipping point for the individual investor? Do new highs in equity markets signal a new trend, or a warning?

I have some thoughts on individual investors which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

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.

The Good

This was a very good week, both for data and for earnings. The big complaint from some will be that some of the good news was "pulled forward" by the prospects for higher taxes. The emphasis this week is on the positive, but that is what actually happened. Over several years I have always sought balance, but I will not distort news to give a false impression. Things are getting better, and that is something you should know.

Congress! I understand that for most, this is difficult to believe. At the start of a new Congressional term we have a little distance from the next election. It now appears that there will not be an imminent debt ceiling crisis. CNBC has even taken down the countdown ticker! There are even hints at progress on immigration. The budget issues may return to the normal committee structure, something that I have been predicting for many months. Bottom line? No crisis, significant progress – market friendly.
Home prices. Dr. Ed says, "Home prices may be starting to melt up. That means that fewer homeowners will have negative equity in their homes and more of them will have less of it. That could do a lot to boost consumer confidence and spending, and boost bank profits too." Here is his helpful chart:

Jobless claims seemed to confirm last week's dip to the 300K range. Skeptics still question the seasonal adjustment factors, so we are watching carefully.
ECRI's WLI is making a 95-week high. Analysis from Dwaine Van Vuuren via Doug Short.

The Bad

The thin data week included a little bad news. Feel free to add in the comments anything you think I missed!

Bullish sentiment spikes. On a contrarian basis, this is a short-term negative. (via Bespoke).

Trading in Apple stock. It is a microcosm of the old debate: technical versus fundamental analysis. Historic records in earnings were not good enough for those who see the next Kodak and falling profit margins. The bearish viewpoint took command. (A dissent from Scott Grannis who has some interesting charts).
New home sales are "not pretty". Analysis from John Lounsbury and Steven Hansen at GEI, including this chart:

Fiscal drag from the payroll tax resumption. Dr. Ed has a helpful chart.

The Ugly

Ackman versus Ichan. Traders paused to enjoy the name-calling and also to provide some background applause. The out-of-control commentary replaced the normally-scheduled programming on CNBC. The content was certainly different from the standard fare, but Jon Friedman is skeptical. You would not see this on Meet the Press!

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. Dwaine just announced another intriguing new product. The best way to learn how you can benefit is to check out the 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. I will try to do a more complete review soon. Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year 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 suggests that a retraction of the ECRI call is "long overdue." Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

New Deal Democrat at the Bonddad Blog extends the Bob Dieli analysis into the Depression era, suggesting that deflationary recessions are different. Dr. Dieli offers some comments.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

The Week Ahead

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The "A List" includes the following:

Monthly employment report (F). Expectations are for stronger net job gains. There will also be "benchmark revisions" which will show that improvement was understated last year.
Initial jobless claims (Th). Continuing special interest after the recent improvement. Seasonal adjustments?
Personal income and spending (Th). Important role as concurrent indicator on "recession watch."
ISM index (F). Good read on employment trends and manufacturing.

The "B List" includes the following:

Consumer confidence (T). The Conference Board survey (on which I place less reliance than Michigan's) is still an interesting source of information about employment, consumer expectations, and spending.
Chicago PMI (Th). This is mostly interesting as the single best read on the national ISM report.
FOMC decision (W). Given all of the prior discussion, this should not be a surprise.
ADP private employment (W). A good forward look on Friday's big employment number.

And of equal importance with the economic data, we have an avalanche of earnings stories. We are moving from the financial and tech stocks into some of the big cyclical names.

Trading Time Frame

Felix continues his bullish posture, fully reflected in trading accounts. Felix has been cautious, but still has caught most of last year's rally, and did so with less risk. Felix is once again reflecting a very bullish posture, with plenty of breadth. The ratings are not consistent with a toppy market.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

If you are thinking of going it alone, you might want to follow my series of book reviews for individual investors. I have more (promised) installments to come. I have written over thirty book reviews in the past seven years. The current series has a focus on the individual investor who wants to go it alone. The TV commercials make it seem so easy! Here are the first and second installments.

Rather than do a weekly update for investors, let me refer readers to my 2013 preview for Seeking Alpha. This covers key investor catalysts, as well as some specific stock and sector ideas. My recommendations did well last year, and we are off to another good start. You need to be comfortable in taking the other side of one of the most hated rallies in history.

Final Thought

There are two quite different perspectives about investing prospects:

Any time there is a rapid move of 5% or so it is time to take profits.
A significant move might mark the long-awaited return of the individual investor.

There is a growing awareness that the second theme may have some real legs. This was the conclusion of a recent Bloomberg survey. The following are the top points, but there are many others in the full article:

38 percent, the highest, expect the US to be in the top two markets over the next year, followed by China.
53% say equities offer the highest return in the next year, the most since the poll began in July 2009.
Nearly 66% plan to increase equities during the next 6 months.
35% say the global economy is getting better, twice the number who say it is getting worse – Europeans were the most upbeat, Americans the least.

The survey respondents are actually correct. As we have noted in this column, week after week, the fundamentals have improved. Risk is lower. The economy is doing better. Corporate revenues are encouraging.

The old market highs are not some impossible barrier. They represent completely different circumstances in terms of risk, government policy, and earnings.

For a great summary, read Cullen Roche, covering the David Tepper appearance on Bloomberg. This is a noteworthy "never before bullish" call. Cullen highlights the following:

On why now is a good time to be long:

"Listen, you're sitting here in a 2% to 3% growth situation. You have some very interesting news last week. The Republicans are not going to play with the debt ceiling. If they pass legislation on Wednesday, you probably have five months of relative quiet. So three months extension plus two months they can play games to extend it further. You really have a little bit of change in attitude that you will probably not have a debt ceiling fight. There is no major negative. You have these earnings, this money growth. You have the Japanese coming on top. There is no other choice out there. You really have not had this money supply push on a relatively good economy. I do not think it is really a steaming pile of garbage, using the G word instead of another word."

On when we'll see the shift from credit into equities:

"You saw some of the shift into equities earlier, mutual fund flows. I know people are looking for this great shift. But you don't have to have the shift. You just have to have all new money going into stocks…People make money, they invest money. There is incremental money that people save. The shift will be in new money. And there will be a shift in old money. Pension managers and others are really off sides in how they are set up. Whether you believe a Goldman Sachs report that they're underweighted by under 20% in equities, which is just huge. Insurance companies underweighted in equities. Just incredible underweights. So I think either you will have a shift or you will see all incremental funds move into the equity market over the course of this year. And then I think you will have a retail shift this year too at some point."

January 28, 2013 in Individual Investors, Markets, Sentiment, The Week Ahead | Permalink | Comments (0) | TrackBack (0)

January 21, 2013

Do You Understand Ceteris Paribus?

Since no one seems to take Latin any more, you probably cannot translate "ceteris paribus."

Real economists frequently cite the need to explicitly state the assumption that "all other things are equal."

In the blogging world, the biggest voices on economics are not economists. This should not surprise us. The pop economists are playing to our vision of reality:

State what the reader already believes;
Provide data that appears to support the belief; and
Add some bogus conclusion.

It happens every day.

Background

I am going to reveal something personal and unprofessorial. I like Jack Reacher – the character, the strength, the simplicity of needs, the moral compass, and of course, the ability to "connect."

Like many others, I was interested in the upcoming movie. How could Tom Cruise portray this giant? In reading about the story I discovered something interesting about investments. Lee Child is a pseudonym and the Brit who is actually writing is a guy named "Jim Grant." No, not that one!

In a great story by Brian Curtis at Grantland the author reveals why his work is so persuasive and sells so well:

Although he'd never lived in the U.S., Grant had visited frequently, had lapped up American TV, and had even married an American woman. "It was really a question of mimicking," he says. "If you're familiar with the rhythms and the word choices of the country and you can put them down on paper, it actually becomes their nationality." British drollery metamorphosed into a kind of hypnotic, Eastwoodian growl. Killing Floor, the first Reacher book, opens like this:

I was arrested in Eno's diner. At twelve o'clock. I was eating eggs and drinking coffee. A late breakfast, not lunch. I was wet and tired after a long walk in heavy rain. All the way from the highway to the edge of town.

Grant's wife, Jane, read his drafts and clipped out Britishisms. She called herself the Committee on Un-American Activities.

The Americanness of Lee Child's novels did not come from granular detail, from a novelistic sense of place. "You know you're in Nebraska because he says, 'We're in Nebraska,'" notes Otto Penzler, the owner of New York's Mysterious Bookshop. "You don't smell the cornfields."

No, Child aims to deliver a different American vision. When Reacher goes to Nebraska, as he did in Worth Dying For, Child borrows images from movies and TV shows — it's a "Nebraska" of our collective imagination. As Child puts it, "If you stick to that mental image, everybody says, 'That's a well-researched book.' If you actually supply the reality, people say, 'The guy's never been there.'" It's as if Child is feeding back to us the images America once beamed to England.

Investment Implications

Bringing this back to the world of investments there is a clear conclusion:

The great novelist of thrillers reveals the technique of the great fiction writers of economics!

They are telling you what you think you already know – not trying to inform.

Spotting These Imposters

The biggest tipoff to the pop economist is when he/she does not say, "ceteris paribus." This means that the author is trying to change only a single variable in a multivariate world – an amateur approach.

Here are two current examples:

Profit margins. We have all heard ad nauseam that profit margins are mean-reverting. The blunder of this one-variable approach is a failure to consider why profit margins are so high. Corporations have squeezed employment and costs. Think lean and mean. Those taking this viewpoint have been wrong and the multivariate approach which I endorsed two years ago and again last year has been correct. Profit margins will decline if and only if there is a massive increase in revenue and gross earnings. There is still time for investors to grasp this concept, since the wrong-headed bearish viewpoint prevails.
Interest rates. Suppose interest rates were to move higher, forcing greater government expenditures and offering a more attractive alternative to stocks. The Fed might go broke! I need to write more on this theme, but the concept is the same. The Fed is actively trying to increase inflation expectations. They want to encourage investment. That is the plan, little understood by traders. So there is no "ceteris paribus." When interest rates rise, the move will be accompanied by a vigorous economic rebound, including business and consumer investment.

Only the pop economists isolate on one variable and project the worst case.

January 21, 2013 in Contrarian Investing, Individual Investors, Markets, Reviewing Pundits | Permalink | Comments (4) | TrackBack (0)

An eclectic approach to better trading and investing. Finding market inefficiency. Discussing and applying the best ideas and methods from several disciplines.

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March 03, 2013

February 27, 2013

February 17, 2013

February 09, 2013

February 05, 2013

February 02, 2013

Correction Ahead

Probable New Highs

A Longer View

Background on "Weighing the Week Ahead"

Last Week's Data

The Good

The Bad

The Ugly

The Indicator Snapshot

The Week Ahead

Trading Time Frame

Investor Time Frame

Final Thoughts

January 31, 2013

January 29, 2013

January 28, 2013

January 21, 2013

Individual Investors: Start Here!

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