I expect investors to join others in a close watch of coronavirus developments.
The economic calendar is a big one, including the employment report and the ISM data. We’ll have plenty of political news and corporate earnings. Despite these candidates for attention, I expect investors to join others in a close watch of coronavirus developments. As usual, there are many newly minted experts ready to describe the investment implications. It is not an easy task, as we shall see in today’s post. Expect the punditry to be asking:
Should investors bail out, sit tight, or wait for more information?
Last Week Recap
In my last regular installment of WTWA, (two weeks ago) I highlighted the importance of watching corporate earnings reports. That has indeed been a regular topic, despite competition from other breaking news.
I hope readers also checked out my Seeking Alpha 2020 preview article, where I always enjoy the opportunity to write about a different time frame.
Mrs. OldProf likes KC because of their unstoppable offense. (Actually, I think she has a crush on their Quarterback). I like the parlay of Niners and under, since I think a victory for them will only come if their defense prevails.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring Investing.com’s version. If you go to the interactive chart online, you can see the news behind each of the “N” callouts.
The market lost 2.1% for the week. The trading range was 2.4%, although it felt larger to most observers. Monday trading was weak. The mid-week rebound was erased –and more – on Friday. In general, each decline was attributed to the coronavirus story and the rebounds to “the market shrugging it off.” You can monitor volatility(NYSEARCA:VXX), implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
New Deal Democrat’s high frequency indicators are an important part of our regular research. This report is fact-based. NDD is consistent with the package of indicators. Each has a source and often an accompanying chart. This week shows that indicators in all time frames remain positive, although the short-term and most volatile group is only a weak positive. Read the entire post for NDD’s commentary on the specifics.
- Mortgage applications were very strong, rising 7.2% versus last week’s decline of 1.2%. The start is even better than last year’s excellent performance.
- Durable goods orders for December increased 2.4% versus expectations of 0.5% and November’s downwardly revised loss of 3.1%.
Consumer confidence in January was strong and improving. This week I show results from three different survey methods.
- The Conference Board indicator was 131.6 beating expectations of 128 and the upwardly revised December reading of 128.2
- Michigan sentiment registered 99.8, beating expectations and December’s reading – both 99.1
- Gallup’s polling also shows economic confidence at the highest level since 2000.
- PCE prices were roughly in line with expectations, with the closely watched core rate up 0.2%.
- GDP increased 2.1% according to the first estimate for Q4 2019. This beat estimates of 1.8% and equaled Q3. A closer look at the data is less encouraging. Dr. Robert Dieli shows the contribution of components, broken down into “core” and “noncore” categories. His full report explains why the import contribution is unusual and misleading. Consumers are doing the “heavy lifting.”
He also describes the results in terms of cyclical and non-cyclical economic activity. The dramatic changes over the course of the year become obvious.
Jill Mislinski provides another useful perspective on the rate of economic growth – considering GDP per capita.
She points to the dramatic change in trend at the time of the Great Recession.
- New home sales for December were 694K (SAAR) missing expectations of 725K. November was revised lower, from 719K to 697K. Calculated Risk points to the year-over-year results – up 23% over December 2018 and the 2019 total up 10.3% from 2018. He notes that comparisons will be “fairly easy” in the first five months of 2020, but more difficult later.
- Pending home sales for December declined 4.9%, versus expectations of a gain of 1.0% and November’s 1.2%. Calculated Risk also comments on the relationship between new and existing home sales. For many years there was a tight relationship. Following the housing bubble there were many distressed sales. Bill has consistently followed this “distressing gap” which persisted as builders(NYSEARCA:XHB) focused on more expensive homes. That is changing.
Personal income for December increased only 0.2% missing expectations of 0.3% and worse than November’s downwardly revised 0.4%. Once again, the year-over-year viewpoint looks quite different. (First Trust).
Personal income and spending continued to rise in December, closing out 2019 on a high note. For the year, personal income rose a healthy 3.9%, while spending increased 5.0%, tied for the largest annual increase going back to 2006. Within income, gains for both December and full-year 2019 were led by private-sector wages and salaries, which rose 0.3% in December and are up 5.5% over the past twelve months. Incomes were further supplemented in December by a rise in interest income which helped offset a decline in farm proprietors’ income (due to lower subsidy payments from the Department of Agriculture to farmers impacted by the trade skirmish). Higher incomes, in turn, continue to drive spending, which rose 0.3% in December. Purchases picked up for both goods and services, as a drop in spending on autos and energy products (both gasoline and home utilities fell in December) was more than made up for by increased spending on medical care, food, and recreation.
- The Chicago PMI for January registered only 42.9, far below the expected 48.7 and December’s downwardly revised 48.2. [Jeff – I have often noted that this report has more importance when it comes on a Friday. It is seen by many has a clue about the ISM manufacturing survey. This week’s big miss came in the context of the coronavirus stories, amplifying the impact.]
- The earnings “beat rate” (69%) and amount above estimates (4.1%) are both somewhat below the average for the last five years. (FactSet). Here is the summary by sector.
Earnings expectations are also declining with 2020 now expected to show a 4 – 5% year-over-year increase. (Brian Gilmartin)
The Department of Justice also released the names of two Chinese researchers who allegedly acted against US interests.
$50,000 per month, generous living expenses, and $1.5 million to establish a research lab at Wuhan University of Technology? All while getting federal funds from multiple agencies?
The Week Ahead
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.
The economic calendar is a big one, including several of the most important economic reports. Both ISM manufacturing and services and the monthly jobs reports. There will be plenty to analyze.
We’ll also get another 20% or so of the S&P 500(NYSEARCA:SPY) earnings reports.
The Iowa Democratic caucuses will take place on Monday, the first actual voting in the 2020 Presidential race. The President will deliver the State of the Union Address on Tuesday with the impeachment vote scheduled for Wednesday.
Until there is more information on coronavirus containment, that issue will remain front and center.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
With so much going on, anything might turn out to be a theme for the week. Often it would be the employment data or corporate earnings. How can anything top impeachment and the first part of the 2020 election as topics? The market will get around to those topics. But first comes the need to reduce uncertainty. How should investors evaluate the spreading novel coronavirus?
Is it a time to sit tight (whether in the market or note)? Is it a time to learn something new?
Should it be analysis or paralysis?
As always, a new worry generates a new bundle of experts to help us. A close look often shows that these are old experts who now claim knowledge of a new field! Many of them have strong opinions about your investments. I spent most of the week learning from some experts who were new to me. I then pieced together a series of points that covers the key questions. As you will see, it is not specific advice, but it should be a good guide to your own analysis.
Determining the Facts
The source of the coronavirus and transmission from animals. This is a great interview with EcoHealth Alliance President Peter Daszak.
Researchers are working on the source, whether it is evolving and the size of the ultimate threat. (The Scientist).
An example – just one – of the detailed work being done. (New England Journal of Medicine).
How fast can it spread?
Here is the comparison to MERS.
There is now a report of the first death outside China. More countries adopt border restrictions.
Here are the key factors on how bad it might get. (NYT) This is a very good background article covering contagion, how deadly, how long for symptoms, amount of travel by those infected, evaluation of a response, and the chances for a vaccine. The article has some great graphics showing the results of various models. Much depends upon how many people are infected by each new case.
Barron’s reports on a model that zeroes in on China’s ability to quarantine its infected population.
If China can effectively quarantine its infected population by March, Cascend’s model forecasts, as few as 30,000 people will be infected, with 13,500 deaths. That is a lot of people, but as the Cascend report notes, the common flu kills 35,000 people a year and hospitalizes about 200,000 in the U.S. alone.
If the infected population isn’t quarantined by September, however, the number of infected people could reach 800,000, lifting the death toll to 200,000. The figures could reach 2.3 million infections and 600,000 deaths if the world can’t quarantine the infected population by the end of 2020.
Who is best prepared? (Statista)
Even though Chinese authorities have said that they have observed evidence of person-to-person transmission, health officials in Orange and LA countries in the United States have said that the precautions in place should stop any spread of the coronavirus. That raises the question: which countries are the most and least prepared to contain large outbreaks of disease?
Are people collapsing in the street? (Snopes)
The Heisenberg highlights Joe Weisenthal, who caught an important bogus news report, released when bond yields were already declining.
The Fear Trade is Alive and Kickin’… writes Mike Williams. He writes about the noise about “this latest monster” and a possible recession will add to the worries that fuel market rallies.
Any pundit who has predicted a market crash is warning that this is the start. You have already been bombarded with these stories, so I will not cite any.
Finding a Bright Side
Could there possibly be a bright side to this deadly disease? One official had this to say in response to a question from Maria Bartiromo:
“Well, first of all, every American’s heart has to go out to the victims of the coronavirus, so I don’t want to talk about a victory lap over a very unfortunate, very malignant disease,” Ross said in response to her point.
“But the fact is it does give businesses yet another thing to consider when they go through their review of their supply chain on top of all the other things, because you had SARS, you had the African swine virus there, now you have this,” he added.
Ross said the virus is “another risk factor that people need to take into account,” and he then made that prediction about North American jobs.
You really can’t make this stuff up.
Help from the Fed?
I saw several articles wondering what the Fed would do to deal with the crisis. Amazing! Apparently, some believe in the need for a third Fed mandate. Meanwhile the expectation of more rate cuts increased.
The general news summary is that the virus will weaken Chinese economic growth and that will weaken the rest of the world. This story does a great job of providing anecdotes to make the case persuasive, but it does not help much with a quantitative handle on the problem. Employees, closings, supply chain problems – all true. Impulse buys and trips are lost to the economy forever. Other items are merely delayed.
One estimate is that the economic impact will exceed the $40 billion attributed to SARS, mostly because the Chinese economy is larger.
There are many sources suggesting a stock price decline. Art Hogan (CNBC) says the market could pull back 3-5% because stocks “are relatively priced for perfection, and you tend to have a bit of an overreaction to bad news or in-line news when that happens.”
Paul Schatz says the unsurprising pullback has established a new trading range.
What about a vaccine?
A vaccine is at least a year away. (STAT)
One problem is that the financial models for drug development do not promote vaccine research.
It is easier to answer in the negative. What should investors not do? Become paralyzed? React blindly to sources with no insight? We need more facts and we’ll have them soon.
I’ll describe my own approach to this difficult question in today’s Final Thought.
Quant Corner and Risk Analysis
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.
Both long-term and short-term technical indicators remain neutral, but deteriorated significantly during the week.
The C-score remains in a zone which suggests that we watch for confirming data. Like others, we don’t see much of that. The yield-curve flattening will show up in the indicator next week.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score”.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
GDP expectations are drifting lower.
So much for the “January barometer.” (CNBC) Don’t worry, the lesson will be forgotten by next year! Meanwhile, I am cheering for the Niner’s and that Super Bowl indicator.
Insight for Investors
Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely
Best of the Week
If I had to recommend a single, must-read article for this week, it would be Aswath Damodaran’s An Ode to Luck: Revisiting my Tesla Valuation. Prof Damodaran’s analyses are always rigorous, with a lesson about methods in addition to useful information about the company. This post is especially interesting because he has been on both sides of the investment debate about this popular stock. First lesson: He warns against the dangers of bias.
When investing, I am often my own biggest adversary, handicapped by the preconceptions and priors that I bring into analysis and decision making, and no company epitomizes the dangers of bias more than Tesla. It is a company where there is no middle ground, with the optimists believing that there is no limit to its potential and the pessimists convinced that it is a time bomb, destined to implode. I have tried, without much luck, to navigate the middle ground in my valuations of the company and have been found wanting by both sides. For much of Tesla’s life, I have pointed to its promise but argued that it was too richly priced to be a good investment, and during that period, Tesla bulls accused me of working for the short sellers. They did not believe me when I argued that you could like a company for its vision and potential, and not like it as an investment. When I bought Tesla in June 2019, arguing that the price had dropped enough (to $180) to make it a good investment, they became my allies, but that decision led to a backlash from Tesla bears, who labeled me a traitor for abandoning my position, again not accepting my argument that at the right price, I would buy any company. I would love to chalk it to my expert timing, but luck was on my side, the momentum shifted right after I bought, and the stock has not stopped rising since. When Tesla’s earnings reported its earnings yesterday (January 29th), the stock was trading at $581, before jumping to $650 in after-market trading. It is time to revisit my valuation and reassess my holding!
He describes his first valuation, when it was a “story stock.” He highlighted the debt, created a distribution of outcomes, and put in a limit order to buy at $180. You can download his spreadsheet from the post. Second lesson: Don’t pick a specific target price; look at a range of outcomes.
His buy point was almost the very bottom. Was his spreadsheet that good? Lesson three: Don’t mistake dumb luck for skill. He describes several factors that combined for a turnaround, but the timing was lucky.
Next, he analyzes the improvements that he can put in his spreadsheet model. Some relate to company performance, while others reflect external markets, e.g. lower interest rates. He then does a sensitivity analysis, showing which of the factors was most important in the new estimate. Lesson Four: Maintain rigor when evaluating your winners.
Finally, he contemplates the valuation reached, $427, and the price post earnings — $650. That is in the 90th percentile of his value distribution. Like most investors, he likes to hold his winners and he thinks about taxes. Could he hold out until June, when it would become a long-term gain? No. He sold at $640. Lesson Five: Don’t let tax considerations stop you when it is right to sell.
Chuck Carnevale highlights the top three medical distributors. He sees strong fundamentals. He also provides a great lesson on how to find and monitor stocks like this. He accurately notes the list of questions that the investor should ask. Drawing upon his invaluable FASTgraphs analysis, he concludes:
From the above screenshots, each of these dominant medical distributors are clearly trading at significant discounts to their fundamental values and their historical norms. Moreover, this also suggests that, as I previously stated, it is sector rather than company specific. The negative sentiment surrounding these companies despite good fundamentals are related to the “opioid epidemic and not too weak business results.” Consequently, we might initially want to look at what the potential liability that each company might face.
He goes on to consider that question. Chuck remains one of the greatest sources of ideas and analytic methods.
How about Netflix (NFLX)? Beth Kindig does her typical great job of analyzing the company, its market, and its competitors. You will get an important lesson from reading the post. Time to buy? She expects a better opportunity and eventual expansion to new markets.
James Hanshaw provides an excellent description of the growing use of hydrogen as a fuel. He reviews the history, the current push for this environment-friendly approach, and the overall potential. He even provides a specific idea, Linde (LIN).
How about international dividend stocks? Barron’s cover story provides some ideas. This list has plenty of energy names and banks.
Brad Thomas likes Tanger Factory Outlet Centers – despite getting the boot from S&P’s High-Yield Dividend Aristocrats Index. Read the full post to see why the author thinks you should look beyond this event. Hint: He likes dividend increases.
David Templeton highlights New Dividend Aristocrats for 2020.
4 Bargains to Be Found Among Stocks Hit by Coronavirus Fears. Airlines and energy?
Stone Fox Capital likes Baidu (BIDU) after the coronavirus fades.
The Great Rotation
Did you know this?
The top two names in the S&P 500 index have a combined market cap of $2.67 trillion. The total market cap of the Russell 2000 was $2.5 trillion at the end of 2019. When U.S. prosecutors were talking this summer about what they should do about Facebook, Alphabet‘s Google [GOOGL], and Amazon, it was a powerful moment. There will be more government scrutiny [of some megacaps]. Another bubble in the past five years has been the assets that passive investing attracted. Much of that has gone into large-caps. We didn’t have this—or zero interest rates—in past periods.
And here is a good perspective on long-term events and the proper time frame.
There is a high possibility of active managers in small-caps doing well. We are coming out of a low-rate environment; we aren’t going to have rates go from 5% to 1.5% again. More research people have dropped out of the small-cap world; there has been shrinkage [in the public stock universe] with fewer initial public offerings, but there are thousands of companies—15,000 to 20,000 globally. International small-caps have a first-rate opportunity in the years ahead. It’s like the small-cap world was in the late 1980s domestically, with a long runway to come.
We also have the luxury of looking very long term. It is one of the few remaining things that we can do in a cool way: time arbitrage. We are able to take advantage of what the market thinks today and what we think is happening five years from now.
More information on FAANG or FAANGM as the membership changes.
Watch out for
Market timing. Nick Maggiulli writes Why Market Timing Can Be So Appealing. He asks why hoarding cash to “buy dips” is “such a seductive idea, despite the overwhelming evidence against its success?” One answer is that the ideas is usually right!
For example, if you randomly picked a trading day for the Dow Jones Industrial Average since 1970, there is a 95% chance that the market would close lower on some other trading day in the future. This means that only 1 out of every 20 trading days (i.e. ~1 a month) closes at a price that will never be seen again. Only 1 in 20 trading days offers an absolute bargain.
Read the full post to see how little perfect knowledge of bottoms, which of course we don’t have, improves a dollar cost averaging approach.
The coronavirus is an unusual test for investors, but not unique. The real challenge is to avoid a trap:
Especially on this sort of issue there is nothing you can learn from the market action. The “message” of the market is distorted in this modern trading era. Here are the steps:
- Algorithms, trained on past market reactions, react to key words.
- Human traders observe and participate in the moves.
- Intra-day stories jump on the market move, imputing deep significance regardless of facts or the size of the move.
- Nightly news stories, needing an explanation for what happened, grab the nearest handy narrative.
This is a market of noise, not message. There is an eventual verdict of course, but we don’t see it in this time frame.
Great Rotation Hint of the Week
For those unwilling to do the work on individual stocks, you can get part of the bang for your buck on well-chosen ETFs. Michael A. Gayed nominates the Vanguard Mid-Cap ETF (VO)
If you want to outperform the market, I think you have to find sectors or investments that have been under-owned and underperformed for several years. The most likely way to beat the market is to invest smartly in things that will have a reversion back to the mean. One glaring sector I have found in my research that needs to be highly owned is the mid-cap sector, and a great way to get invested in it is the Vanguard Mid-Cap ETF (VO).
My plan? Find the key variables and react accordingly. I need to know the rate of transmission. I need to know how well containment plans are working. We’ll know both pretty soon. I then need to estimate the economic impact. If it is a one-time, one-month hit, mostly on the Chinese economy, it is a temporary and modest hit. If the virus affects many workers, consumers, and commerce around the world, it will be longer and more significant. This is an important issue, but action is not urgent. I have time to learn.
But…..I need to seek out expert sources of the type I cited today. Knowing how to find real experts is an important investment skill.
My default strategy remains one of taking advantage of volatility. With more information available soon, I am buying a little more gently than usual into the decline.
There is a difference between importance and urgency. Great investors do not confuse the two.
[This is a time of great risk and great opportunity – a bad place to make a big mistake. Do you know how to evaluate the current news? Is your portfolio ready for the Great Rotation? Are you overloaded with risky, overpriced stocks? If you are unsure, write for my brief paper on Four Signs of Portfolio Trouble. Just send an email request to info at inclineia dot com].
Some other items on my radar
- A randomly weak employment number that will be treated as laden with significance.
- The lagging business Cap-ex.