Weighing the Week Ahead: Awaiting The Economic Data Message

Courtesy of Doug Short.

Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

Employment week always generates a strong economic focus. Because it falls on an early calendar day this month, we also have an avalanche of other economic reports.

This week will emphasize the message of the economic data.

What can we learn from this news?

Prior Theme Recap

In my last WTWA I predicted that the media would focus on “divergences” and the implications for the broader market. I was out on a limb with that one, since it was certainly one of the more obscure possible choices for a weekly preview. It turned out to be very accurate. Doug Short’s review and summary chart provide one-stop shopping for what happened in equity markets.

The news was actually pretty good, but you would not know it from the markets. The decline on Thursday provided grist for the “divergence theorists.”

Here are some headlines:

From BlackRock: Worlds Apart? Investing in an Era of Divergence
From Thursday at MarketWatch: This stock selloff has everyone talking about ‘divergence’

Some of the stories even cited the same sources and charts I used. Apparently I was on target.

Feel free to join in my exercise in thinking about the upcoming theme. We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead.

A Note to Readers

Sometimes I try to review my approach to the WTWA series. As a profitable blogging method it is rather dubious. I could get many more page views if I split apart the various concepts, creating several posts per week. My sense is that the article would not be as helpful, but many prefer short takes on specific topics. Here is what I am aiming for:

A thoughtful theme that provides an organizing concept for the week ahead.
A frank assessment of how well we guessed about last week.
A summary of the good, bad and ugly news from the prior week. Ideally, this includes items you do not see anywhere else.
Recognition of peers who have done courageous and excellent work via my Silver Bullet.
A data-driven summary of the best quant methods.
Some ideas for traders.
A lot of ideas for investors.
Plenty of charts, tables to tease with links to the best of what I read last week.
My own take on interpreting the news of the day.

Some readers will not be interested in all of these topics, but I have organized it so that you can find your favorite parts. Can I do better, either in approach or content? Suggestions are welcome.

This Week’s Theme

In sharp contrast to last week (little fresh data, plenty of room for navel gazing) the week ahead includes plenty of new information. Many observers will try to force the data into their pre-conceived themes. Here are the key competitors:

Commodity markets show that global economies are weak. (See this discussion of declining commodity prices).
Bond yields imply a weak economy. (Gundlach CNBC interview).
The bond message does not signal weakness
- It reflects European yields and arbitrage (Yardeni)
- Yields are normal for this stage of the business cycle (Grannis)

The Scott Grannis analysis, above, covers a key point that seems to elude most investors – the exaggeration of the effects of Fed policy, especially on ten-year rates. He writes as follows:

10-Year yields, on the other hand, are largely driven by the market’s expectations for economic growth and inflation. The Fed can influence these expectations to some extent, but not by much. The chart shows that even though the Fed purchased trillions worth of notes and bonds in three rounds of Quantitative Easing, 10-yr yields rose during each episode of Quantitative Easing. Yields rose because the market perceived that the Fed’s bond purchases were correctly addressing a problem and thus improving the outlook for growth. Yields fell after QE1 and QE2 because the market realized that the Fed had not done enough to address the world’s demand for safe assets, and this threatened the outlook for growth. We now know that QE3 is virtually finished, but yields have only declined marginally, which in turn suggests that this time the Fed has done enough.

As usual, I have a few thoughts about which approach is best. First, let us do our regular update of the last week’s news and data. Readers, especially those new to this series, will benefit from reading the background information.

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

There was a lot of very good news, supporting the general thesis of economic strength.

Gas prices declined another five cents. Doug Short monitors this every week, with the impact on the CPI and great historical charts. Take a look.
Q214 GDP was revised higher. This is “old news” of course since we have almost completed Q3. As I noted in last week’s preview, it still explains the foundation for future economic analysis. Bob McTeer likes the source of the revisions in the recent report – exports and business investment.
Business investment is improving. (Scott Grannis). Capital goods orders are a good proxy. This supports the GDP news.
Michigan sentiment reaches a 14-month high. Doug Short has a full analysis, as well as my favorite chart of this series.

Click for a larger image

Durable goods orders increased in the core measurement by 0.7%. The noisy headline number reversed the aircraft news from last month. That was expected, so I am treating the news as a net positive. Steven Hansen at GEI does an excellent job of explaining the apparent contradiction.

New Home Sales beat expectations. Calculated Risk reminds us that this is just one month and it was an easy comparison. I am scoring it as a positive, but we should keep the warnings in mind. (Please compare with the “bad news” on existing home sales).

The Bad
There was also some important negative news.

Ukraine story. The effects of this continuing saga appear in the weakness of the European economy and dollar strength. In the short term, these are both negative factors for stocks. My estimate is that the market effect is currently about 8-10%. I do not expect a sudden change in the story, but I monitor it closely. To understand why it has been bad news, here are some current headlines:
- Russia sees US and EU as backing Ukraine “Coup” (Voice of America)
- Sanctions hurting Europe more than Russia? (Reuters)
- Ukraine faces a cold winter without Russian natural gas (Calgary Herald). (See also quotes from Ukraine PM in many sources, including Reuters). Europe, too?
- US sets reform conditions for Ukraine investment. (Yahoo Finance)
Sentiment remains bullish. A bit less so, but still tilted that way. Bespoke has the AAII survey and discusses the expected contrarian interpretation.

Economic growth is decelerating via the Chicago Fed’s activity index. Doug Short has a good analysis. Many of the leading GDP tracking measures are showing growth at 3.5% or so, which does represent deceleration. The headlines can be tricky.
Argentina is tanking. It might also reflect broader South American concerns. Scott Grannis has a good account, illustrating what happens when you peg a currency in a weak economy (chart below).
Existing home sales disappointed. Calculated Risk reminds us of the importance of inventory, which is not seasonally adjusted. With that in mind, the story is not so bad. The housing numbers are a challenge to follow, which is why we read Bill’s reports on all things housing (as well as other matters). Please compare with new home sales in the “good” category.

The Ugly

This week’s “ugly award” goes to the cozy treatment of Goldman Sachs by the New York Fed. You can read a summary by Michael Lewis and also listen to the NPR story at This American Life (available by podcast). I did both. This is only the beginning of the story, I suspect, but the reporters did well to seek balance and offered chances to respond. Neither Goldman nor the NY Fed provided much. I had a unit in my college classes about “captured” regulators. It is a familiar topic without easy answers. Listening to the podcast provides an interesting insight into the issues.

Our “ugly” list for the last few weeks remains unfortunately accurate. We had headline news from all conflicts with plenty of violence and death competing for our attention. The Ebola crisis, which we started to feature many weeks ago, is deepening. Last week I noted that some were calling it a “Katrina moment” for the World Health Organization.

Sometimes the concerted attention to a problem can change the result. Carl Bialik at FiveThirtyEight suggests that the worst of the CDC forecast might be averted for this reason. My investing audience might remember this effect from the Y2K problem, where advance publicity may have contributed to an advance solution. If only we could have a similar result with Ebola!

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger. This week’s award goes to Michael Batnick, who sought the true story about the “death cross” in the Russell 2000. Please read his entire explanation behind this table:

Quant Corner

Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this weekly update. For more information on each source, check here.

Recent Expert Commentary on Recession Odds and Market Trends

Doug Short: An update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI (three years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion concerning continuing economic weakness in Japan. Doug covers the possible implications for the US. The ECRI has nothing fresh to add, but I expect something soon because of their excessive emphasis on commodity prices.

Bob Dieli does a monthly update (subscription required) after the employment report and also a monthly overview analysis. He follows many concurrent indicators to supplement our featured “C Score.”

RecessionAlert: A variety of strong quantitative indicators for both economic and market analysis. Dwaine’s “liquidity crunch” signal played out as projected. This week he highlights his HILO Breadth index which he has designed to pinpoint bottoms and to warn of protracted corrections. Current readings imply an opportunity that usually shows up only once a year. Check out the full post for a description and charts.

Georg Vrba: Updates his unemployment rate recession indicator, confirming that there is no recession signal. Georg’s BCI index also shows no recession in sight. Georg continues to develop new tools for market analysis and timing. Some investors will be interested in his recommendations for dynamic asset allocation of Vanguard funds. Georg also is working on methods to improve performance from low-volatility stocks. I am following his results and methods with great interest.

I added to the recession discussion with some comments on the 2011 ECRI forecast and a possible repeat given current commodity prices.

The Week Ahead

We have a big week for economic data and events.

The “A List” includes the following:

Employment report (F). Rightly or wrongly, the monthly employment data are the most important economic indicator.
ISM manufacturing (W). Good general concurrent economic read with some lead qualities for employment.
Consumer confidence (T). The Conference Board version reflects both spending and employment.
Auto sales (W). Concurrent economic read from non-government data. Also the F150 indicator for construction.
Initial jobless claims (Th). The best concurrent news on employment trends.
Personal income and spending (M). Important element of the economy and also includes the Fed’s preferred inflation indicator.

The “B List” includes the following:

ADP private employment (W). Valuable and independent read on private employment.
ISM services (F). Younger brother to the manufacturing index, but earning a wide following.
Pending home sales (M). All housing news is important. Pending sales have implications for new sales as well.
Trade balance (F). August data relevant for Q3 GDP calculations.
Factory orders (Th). August data in a very volatile series.

Once again, there is plenty of Fedspeak on the calendar. We might think that there is little fresh news on that front, but we still see surprises that add color to the official statements.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has shifted from neutral to bearish. Most sectors have a negative rating and the broad market ETFs are also tilting negative. Our Felix trading accounts are still partially invested, but not in mainstream equity ETFs. The trading program can sometimes go short via the inverse ETFs. That has not happened in more than a year, but we might see it soon.

I know a few very successful traders — very few! Most of those who try and fail think that they can look at a few charts and see something no one else notices. I embrace some technical methods. It is Felix’s strong suit. The fancier the method, the worse the prospects. Larry Swedroe writes about Problems with Technical Analysis. Here is an entertaining quote:

Martin Fridson, who currently serves on the editorial boards of Financial Analysts Journal, CFA Digest and the Journal of Investment Management,had this to say about technical analysis: “The only thing we know for certain about technical analysis is that it’s possible to make a living publishing a newsletter on the subject.”

You can sign up for Felix’s weekly ratings updates via email to etf at newarc dot com.

Insight for Investors

I review the themes here each week and refresh when needed. For investors, as we would expect, the key ideas may stay on the list longer than the updates for traders. The current “actionable investment advice” is summarized here. In addition, be sure to read this week’s final thought.

We continue to use market volatility to pick up stocks on our shopping list. We do this because we also sell positions when they reach our (constantly updated) price targets. Being a long-term investor does not require you to “buy and hold.” Taking advantage of what the market is giving you is always a good strategy.

Here is our collection of great investor advice for this week:

Investing in Russia? Barron’s features Prosperity Capital, which is challenging the conventional wisdom with Russian investments.

To convince investors that better times are ahead, Westman must stray into the political fray he tries to avoid. Russia hasn’t developed indigenous institutional investors; foreigners own most of the free float in its stock market. That means the best hope for a rebound lies in a global rebranding, peace in Ukraine, and persuading capitalists that Russia will not provoke similar conflicts.

Westman has fought this uphill battle by quitting his London desk for fact-finding missions in Ukraine this year, mingling with Kiev politicians and separatist rebels, and offering investors a view he considers more evenhanded than that from most Western media. “I am convinced there is no plan in the Kremlin to restore the Soviet Union,” he asserts. “We are not trying to defend Russian policy, but to explain their point of view, which is that Russia is the one under attack.”

Looking for beaten down sectors and stocks is part of our value style, so I am interested. It still seems early to me, and the average investor cannot go for the private companies that hedge funds choose, joining them in avoiding the state-owned properties.

Need stock ideas? If you want to beat the market like the big hedge fund guys, you cannot buy hundreds of stocks. Bill Ackman’s six-stock portfolio illustrates the principle. We don’t own any of these, but that might relate more to our strategy, focus, and client risk profiles. Maybe some of these should be candidates for our “high-octane” program.

You cannot buy stocks just because they have declined. Some of them never come back! Ben Carlson has charts, data, and analysis. Here is his summary of stocks that had a catastrophic loss – a 70% or greater decline with minimal recovery.

Meanwhile, some stocks are just out of fashion, even if fundamentals are solid. In this post I explored the contradictions in the current commodity trade and mentioned a couple of stocks that qualify as current strong buys, perhaps with calls sold against them.

Financial media for investors. In yet another strong post, Josh Brown describes the imbalance in incentives (junk food versus eating your veggies). Financial media are escalating misleading rhetoric to gain a share of a declining population. It is too bad that there are fewer incentives for those providing solid investor education. Josh lists a few favorite sites, so take a look and set your bookmarks.

Studying mistakes is important! Morgan Housel explains this very well. The entire post is worth your time, but I especially like this section:

Spend more time studying failures than successes. You can learn more about money from the person who went bankrupt with a subprime mortgage than you can from Warren Buffett. That’s because it’s easier and more common to be stupid than it is to be brilliant, so you should spend more effort trying to avoid bad decisions than making good ones. Economist Eric Falkenstein summed this up well: “In expert tennis, 80% of the points are won, while in amateur tennis, 80% are lost. The same is true for wrestling, chess, and investing: Beginners should focus on avoiding mistakes, experts on making great moves.”

His comments are equally true for top-level tournament bridge. I am sure that Mr. Buffett would agree! You can also see the “flip side” from this article at Scientific American. Most of what investors read is completely biased toward the surviving managers.

Do not over-emphasize short-term returns. Many investors rush to study their portfolios whenever there is any news. This distracts from your fundamental goals, explains Kris Venne.

Most of us would be better off if our 401(k) / IRA had a 30 year lock up feature. Maybe even a 90% surrender charge if cashed in early.

If you are stuck in gold or out of the market completely, you might want to reconsider your approach. The current economic cycle is in the fifth inning. This is one of the problems where we can help. It is possible to get reasonable returns while controlling risk. Check out our recent recommendations in our 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 and use feedback).

Final Thought

The disparity between the fundamental factors of stock valuation and the noisy price fluctuations provides ample ammunition for those emphasizing worries. Instead, I suggest a successful formula:

Analyze the potential for a big risk by monitoring recession odds (very low) and financial risk (also very low). If these risks become high, then cut back your position size. You get this information free of charge each week by reading WTWA.
Pay attention to the growth in corporate earnings, especially expected earnings. You can monitor this by reading Brian Gilmartin. He provides the data you need without the bombast. Here is his current take, showing both continuing solid growth and which sectors are featured.
In the absence of problems in #1 or #2, take advantage of market volatility with confidence, especially in beaten-down sectors.

And most importantly – Ignore the sources that make their profit by scaring you instead of helping!