Weighing the Week Ahead: Signs of another Economic Soft Patch?

Courtesy of Doug Short.

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

With each new week, there is a fresh challenge to the most-hated market rally. Last week it was Cyrpus. As I have suggested over the last two weeks in the WTWA series, this issue created volatility that provided opportunities for both traders and investors.

This week I predict that attention will focus on possible softening in economic data and concerns about seasonal market effects. The “sell in May” contingent has their own version of Daylight Savings Time! They now recommend selling in April.

Will economic data show springtime weakness?

David Rosenberg, the favorite economist for the bearish community, has a fresh take on his personal recession odds:

Rosenberg’s biggest concern is a “fiscal mistake” — meaning that the immediate focus on the deficit would be too great.

I have some thoughts about the seasonal threat which I’ll report in the conclusion. First, let us do our regular update of last week’s news and data.

Background on “Weighing the Week Ahead”

There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world.

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:

1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
2. It is better than expectations.

The Good

There was some encouraging data, but the overall story included both good and bad elements.

• The inventory of foreclosure sales is down 19%. (CoreLogic via Global Economic Intersection).
• Tax receipts and deposits are back to the old highs on a trailing twelve-month basis. See the interesting chart from Ed Yardeni:

• Cyprus contagion was avoided and lines at banks were orderly.
• Michigan consumer sentiment made a strong and surprising rebound to 78.6 in the final report. See Doug Short’s discussion for a look at my favorite chart of sentiment. He also has the Conference Board version, which tells a different story. There are many factors at work here, but the overall story is relevant for consumption and employment.

The Bad

There were several negatives in a mixed week for economic data. Bespoke notes that the pattern over the last two weeks has been for results to miss expectations, which have perhaps gotten a bit too high. Check out their helpful summary table.

• Initial jobless claims were a bit worse than expected, as was the four-week moving average. This chart from Steven Hansen is part of his most recent summary of economic conditions, which he sees as slowly improving. The initial claims chart provides an interesting focus on the last three years.

• Flash PMI’s for the Eurozone continue to weaken. Markit publishes these a week or so before the official numbers. See Global Economic Intersection’s report for a graph showing the tight fit to GDP.
• The Chicago PMI was very weak ? a bad sign for next week’s ISM report.
• Negative earnings pre-announcements have hit a seven-year high. See Josh Brown’s analysis of FactSet data and this chart:

The Ugly

North Korea announces a state of war. NPR notes that the chances for miscalculation have increased:

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 well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively. In the past, most recently October, 2011, 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.

As part of the weekly indicator snapshot I emphasize the best methods for forecasting recessions. For the last eighteen months this has focused on the erroneous ECRI recession claim. For some reason, the main financial media do not give adequate recognition to any of the sources we follow, preferring to feature the ever-changing ECRI story.

If you have followed the sources I recommend, you have done well. Let us summarize their work.

I 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. Dwaine Van Vuuren also has an excellent data update , demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine’s latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great “quant guy” with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong. His latest article questions the use of M2 as part of the ECRI’s WLI.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now eighteen months old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating — now reflecting the most recent personal income data.

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. A few weeks 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 week brings an avalanche of data.

The “A List” includes the following:

• Employment Situation Report (F). This report is probably the most important in the eyes of the market. I disagree with this emphasis, but I respect the reality.
• Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator, even more than the monthly payroll report.
• ISM index (M). A good concurrent indicator for the overall economy and a helpful predictor for employment.
• ADP private employment (W). This source has been even better than the official measures in recent months, although many disagree.

The “B List” includes the following:

• ISM services (T). The service sector may be more important than manufacturing, but this data series has a shorter history.
• Factory orders (T). Important, but not as timely since it is February data.
• Trade balance (F). Improvement here helps GDP. The results have attracted more attention as US energy exports have grown.
• Consumer credit (F). Anything related to consumer spending is of special interest right now.

Also ? I’ll be watching for any earnings pre-announcements.

Trading Time Frame

Felix has continued a bullish posture, now fully reflected in trading accounts. It was a close call for several weeks. Felix has been long, but in cautious sector choices. At one point we had reduced to 1/3 long in trading accounts. The overall ratings are strong enough for us to be fully invested, but there was a decline over the last week.

I discuss the daily changes from Felix at Wall Street All Stars, where we have a vibrant community with many good ideas. Subscribers can also get answers to questions from several different great sources. My weekly Felix update is usually restricted to subscribers, but I have opened it up for last week. The list is a good source of ideas about what sectors are working. You can also look at the top names in that ETF. I also frequently mention Felix’s favorites among the NASDAQ 100 stocks.

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.”

Investors who have been underinvested in stocks wonder if it is too late to invest. Those who have enjoyed the current rally are bombarded with warnings about the need to sell.

I do not see this year’s current gains as a game changer for the market, and the hoopla about the new record highs is also a distraction. The early move this year mostly reflected an unwinding of fear in front of the fiscal cliff decision. I explained my rationale and emphasized the need to be flexible in adjusting your price targets in this article. The post highlights the reasoning of many analysts who have updated the market prospects rather than remaining locked into a concept created in December.

I also like the assessment from fellow Seeking Alpha contributor Alan Brochstein, Up 10%, Are Stocks Now too Dangerous to Hold? He touches all of the bases in his answer to the key investor question ? market valuation, overheated sectors, the profit margin issue, interest rates, and even some technical analysis. There is no good way to summarize this excellent overview article, so I encourage you to read it.

I invite you also to review my 2013 preview for Seeking Alpha. This covers some 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 ? a conservative, yield-based approach.

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

Markets always have corrections, but predicting the timing is not that easy. Some expected the year to start off with a correction, so they are now 10% behind. Others advocate selling in May. Most would be surprised to learn that stocks usually make gains between May and October. The gains are smaller, but it is not a time where short selling would necessarily be profitable.

It is much better to consider the specific circumstances than to rely on simply trading rules and slogans. What should we expect right now ? from the economy, from corporate profits, and from stocks.

The economy continues a slow growth path with little threat of recession. The Bonddad Blog notes that if you look at the economy as measured by real Gross Domestic Income (GDI) instead of GDP, the Q4 rate of growth was 2.6%, much stronger than the final GDP estimate of 0.4%. Why use GDI? The ECRI insisted that it was the better measure back when it served their purposes. Whatever the measure, Q113 is shaping up to be stronger.

Corporate profit forecasts are improving in line with the economic expectations. Brian Gilmartin has an extensive review of this question, including treatment of specific sectors.

Stock prices in most sectors reflect plenty of skepticism. The new records have been driven by a stampede into anything with a coupon or a dividend. Most investors seem not to grasp the danger of this approach, so we can expect to see some rebalancing from bonds to stocks and from defensive sectors to the lagging sectors of technology, cyclicals, and financials.

And finally, take a look at Jeff Kleintop’s list of ten indicators to watch. They overlap with many of those in our weekly list, but he highlights the group as providing a good warning last year. This year only two of the ten are flashing a warning ? so far!

(c) New Arc Investments
www.newarc.com
Email Jeff