The economic calendar is modest, and the trading week is holiday-shortened. The most important reports all relate to housing – prices, sales, and plans.
With markets viewed as fully or excessively valued by many, there is some renewed interests in finding some attractive remaining sectors. While some political or geopolitical news may well claim the spotlight, even on financial news. That said, this is the closest to a “normal” week for stock analysis that I have seen in a very long time. I expect many to analyze the data and ponder:
Is it too late to invest in housing stocks?
Last Week Recap
My last installment of WTWA, either through operator or software error, overwrote the prior week’s post. It therefore carries the wrong date of February 2, 2020, but it is last week’s story. I’ll replace the actual 2/2/20 post soon. In the meantime, you can check out both stories on Seeking Alpha. I apologize for the error and the inconvenience.
Last week I focused on the headshaking in the pundit community. The markets were not following their perception of “fundamentals.” How could stocks rally in the face of so many problems? That was a good guess for the weekly theme. Such stories were frequent and popular, appearing throughout the week.
I also followed up on my prior coronavirus work. If you read the themes in my two prior posts, you will have a solid background in what is happening and how to follow developments.
As noted above, readers should not have been surprised by the various updates on the coronavirus.
China’s Coronavirus Figures Don’t Add Up. ‘This Never Happens With Real Data.’
Most have concluded that the unexpected increases are the result of improved diagnostic techniques, but uncertainty about data still remains.
Dr. Ed Yardeni, monitoring the key indicators, has this conclusion:
The markets must figure that the coronavirus outbreak will be contained soon and go into remission, as did SARS, MERS, and Ebola. If that doesn’t happen, then there will be a vaccine that will make us feel better. It won’t be a miracle cure coming from a drug company. Rather, it will be injections of more liquidity into the global financial markets by the major central banks.
GDP impact from the WSJ survey shows most seeing only a small impact in Q1 GDP in the US but acknowledging downside risks to forecasts.
GDP potential impact from freight disruption. (Menzie Chinn, Econbrowser).
The possible effects on earnings are showing up on conference calls. (John Butters, FactSet). The FactSet study included a search of transcripts of the 364 S&P 500(NYSEARCA:SPY) companies that have conducted conference calls. “Of these 364 companies, 138 (38%) cited the term “coronavirus” during the call. At the sector level, the Industrials (26), Information Technology (26), and Health Care (24) sectors have seen the highest number of companies discussing “coronavirus” on earnings calls of all 11 sectors.” Only 34 included the impact in modified guidance. 47 did not include an impact, often saying that it was too early or too difficult to estimate.
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 gained 1.6% for the week. The trading range was only 2.0%. As you can see from the chart, much of the gain came on Monday, with a trading range of only 1% for the remainder of the week. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.
My new daily newspaper, The Arizona Republic, is part of the USA Today network. It is far different from the Trib, and I am learning a lot about my new state. I also see tidbits like this one:
About 44% of U.S. adults admit to hiding a bank account or debt, or to spending more money than their partner would be comfortable with, according to a new study from CreditCards.com, which surveyed 1,378 adults who are married, in a civil partnership or living with their partner.
Privacy and control are the main reasons.
In the interest of privacy and a semblance of control, I will not comment on Mrs. OldProf’s audit process!
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 and consistent with the choice of indicators. Consideration of three different time frames helps to clarify economic changes. This week shows an unusual pattern: positive long and short-term indicators, but a neutral “nowcast.” NDD highlights current weakness in production sector indicators (The Baltic Dry Index, rail, steel) but continuing strength in consumer spending.
- Mortgage applications showed continuing strength, up 1.1% on the week. Refinancing also increased to the highest level in seven years. (Diana Olick, CNBC).
- S&P Earnings growth for the first time since Q4 2018. (John Butters, FactSet). David Templeton (HORAN) accurately observe that the growth is much needed since recent market gains have been driven by multiple expansion.
Mortgage delinquencies decreased in Q4 2019. No matter what metric you pick, the story is favorable. From Calculated Risk, quoting MBA’s Marina Walsh, the Vice President of Industry analysis:
Added Walsh, “Signs of healthy conditions were seen in other parts of the survey. The foreclosure inventory rate – the percentage of loans in the foreclosure process – was at its lowest level since 1985. Furthermore, states with lengthier judicial processes continued to chip away at their foreclosure inventories, and it also appears that with home-price appreciation and equity accumulation, distressed borrowers have had alternative options to foreclosure.”
- NFIB Small Business Optimism for January increased to 104.3 from December’s 102.7.
- Michigan sentiment registered 100.9 for February’s preliminary reading. This beat expectations of 99.2 and January’s 99.8. Jill Mislinski has the story and the most helpful chart of this series.
- Gallup polling shows record optimism for the year ahead.
- Hotel occupancy is lower by 1.4%, year-over-year. (Calculated Risk).
- Gasoline prices are increasing.
- The JOLTS report showed a decrease in job openings. This was, naturally, universally treated as bad news for the labor market. My past efforts at explaining this have not been enough. Perhaps a separate post would help. Meanwhile, the key indicators are the ratio of jobs to job seekers (still above one), the quit rate (still high), and the Beveridge Curve which shows the relationship between the unemployment rate and the vacancy rate. One helpful interpretation is that with more entrants to the labor force, the job openings grow fast enough to absorb them. I’m scoring this as “bad” but I don’t really believe it. David Templeton (HORAN) adds that the decline in openings is coming from exceptionally high levels.
- Industrial production(NYSEARCA:XLI) declined 0.3% in January, in line with expectations and slightly better than December’s downwardly revised -0.4%. Brian Wesbury, who usually sees the bright side and is also usually correct, attributes the soft start to 2020 to warm weather that pushed down utility output and the Boeing problems. Read the full post to see some of the problems with this important data series.
Federal debt. The latest budget proposal has landed. Despite the continued economic growth, the deficit will go over $1 trillion.
And that is using very optimistic assumptions about future growth.
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 lighter than usual, but we have a holiday-shortened week. Housing reports are the most important. By contrast, the PPI report is the least important of the inflation indicators. There are fans of the leading economic indicators and Fed fans will be parsing the last FOMC minutes.
We will also get earnings reports from 51 companies in the S&P 500 – 77% have already reported. Despite the conclusion of the New Hampshire election and the impeachment process, there always seems to be some fresh and unpredictable political news.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
Unlike last week, there are few candidates for the weekly theme. Putting aside the possible political or geopolitical stories – all nearly impossible to predict – I am expecting and hoping for a return to discussion and analysis of the economic data. So many were wrong about the housing market that the strong rally and underlying reasons have gotten little attention. With the overall market movements a bit less dramatic, the punditry is beginning to consider the best places to invest. I expect many to be asking:
Is it too late to invest in housing stocks?
Analyzing housing data presents a special set of problems. The 2007-08 bubble and subsequent crash left deep scars on homeowners and investors alike. The temptation to fight the last war is nearly irresistible. The subject is very complicated, so much of the analysis is wrong. It is also easily spinnable. If you are on a mission to present a viewpoint, it is easy to massage the data to fit.
I’ll explain how this works and offer some ideas for finding investments among the chaos. Many readers appreciate the format where I put at least some of my analysis in this section, so I’ll try that again. I’m not going to call out all of those with erroneous forecasts, but many of these contentions were documented in these prior posts and have survived for years despite evidence to the contrary.
|Popular Viewpoint||Jeff’s Take|
|Much of the work on housing invokes the bubble era. One of the most profitable models for investment writers is confirming reader biases. It is easy to take a long list of factors and tick off some that seem to demonstrate similarity with current conditions. Most popular are the Fed keeping interest rates too low, lax lending standards, and low down payments. But there are many more.||There have been many predictions of an imminent crash including a prominent CNBC “expert” contributor and some serial bubble finders.
Testing this proposition should be easy. Look at foreclosure rates, delinquency rates, and affordability data. All have been improving for ten years.
|Lending requirements are too strict, preventing many from qualifying.||Yes, this is the opposite of what bubble-callers say. The criteria have tightened up, so the demand is (properly) lower than it would otherwise be.|
|The economy is too weak to support housing demand.||This claim is popular among serial recession predictors. If you start with the wrong conclusions about the economy, your housing conclusion will also be mistaken.|
|The housing market is too weak to support the economy.||This is another example of taking an apparent relationship and asserting causation. It is great fun to set the direction in order to prove a point. Once again, looking at the correct data helps to solve the problem. New construction is much more important to job creation and economic growth than is the sale of existing homes.|
|Home prices are too high.||Since there is always a market-clearing price, the assertion that prices are too high is a value judgment. Often the statement is “too high for young buyers.”
As usual, this generalization is not useful analysis. Young buyers have differing needs, incomes, and wealth. If prices were lower, generally reflecting smaller homes, they would be more affordable for all buyers.
|Home prices are too low for builders to make profits.||Builders charge enough to make a profit and attempt to keep costs down.|
|There is too much supply of foreclosed homes.||Once true. Now, not so much. Calculated Risk has monitored distressed sales, describing it as a “distressing gap” which eventually would narrow. This has been a helpful and accurate analysis – far better than using conditions from a decade ago.|
|Inventory is too low to meet demand.||This statement is true but does not make the point that the housing market is weak. Businesses strive when the demand is strong relative to the supply.|
|Tax policy is driving down prices in many home markets.||This is true. The limitations on deductions for taxes and mortgage interest have increased costs for homeowners, especially in high-tax states. This creates pressure on home prices.|
Here are a few supporting charts for the points above. They do not fit comfortably in the table format, but I am confident readers will see the relevance.
Investors need to know which sources are authoritative on specific topics. Calculated Risk established credibility during the housing bubble. Bill has been flexible in adjusting his viewpoint to fit the changing facts. Sadly, that is pretty rare, so finding good sources is a challenge. I also recommend the excellent Z Report, which combines proprietary data and expert analysis.
I’ll describe my own conclusions 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 weakened despite the rally.
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 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.
The full post provides charts of the decline from peak levels. A recession requires a significant decline, not just a small apparent rollover. That said, the December weakness stands out, as does the decline in industrial production.
Paul Schatz shows the flaw in simple versions of the January Barometer. This is a nice explanation of the right way to test such a proposition. Hints: Don’t include the indicator period in the results. Compare valid results with other randomly selected time periods.
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 Lyn Alden Schwartzer’s Record Stock Valuations Analyzed. While she describes this as an update on market valuation, there are several investment lessons. She begins with an oft-neglected step — describing what “normal” is like and why that is so. With that in mind, it is easier to consider the variation in asset classes. She uses gold as an asset class to provide a comparison to stocks. From there, she collects evidence to identify risks in various asset classes.
There are a number of interesting conclusions.
- High stock valuations are not explained by increases in foreign exposure among US companies. Her conclusions will surprise many.
- Comparing stocks and bonds, she finds both historically expensive. With that in mind, and using CAPE, she concludes that “equities are fairly priced relative to treasuries in a no-recession scenario.”
- Next what about catalysts for stock valuations to revert to the historical mean. How about a recession, renewed inflation, or higher corporate tax rates. She analyzes each, and also includes some comments on the coronavirus and the possible impact on earnings.
She sees risks as elevated in recent weeks but see some bottom fishing ideas as suitable choices as more becomes known. She also sees US GDP growth as slowing but positive and is concerned about “year-over-year payroll growth grinding lower.”
I am recommending this article for a simple reason – I personally disagree with much of the argument, but not the conclusions! Each position has logic and reasoning and is well worth your consideration. Personally, I hate using CAPE, don’t like ancient data, don’t base plans on future ten-year periods, and have little interest in gold. I don’t see how you can value stocks without considering inflation expectations and/or interest rates. Despite this, I share her market concerns and the basic strategy.
Dr. Brett has another post that is ostensibly directed at traders but is extremely helpful for investors as well. How Overconfidence Derails Our Trading. He explains the trap, the consequences, and a simple technique for helping to avoid the problem.
The full list of “dividend aristocrats” as of the end of 2019. (Motley Fool). The table of the 57 stocks and the number of consecutive annual dividend increases is quite interesting.
Blue Harbinger does a stress test on a popular holding. AT&T: When The Market Crashes. He emphasizes the importance of the dependable dividend. Stone Fox Capital is less enthusiastic. AT&T: Worse Wireless Outcome Possible.
Blue Harbinger analyzes an MLP candidate (for those who don’t mind getting a K-1) and a BDC. It is wise to have expert analysis before you invest in a BDC, rather than jumping at the 9% yield, paid monthly. The post combines a good lesson with the recommendation.
The Great Rotation
As the coronavirus impacts are assessed, the market has turned more cautious on the economy. From the time frame of our four themes, this is economic noise. Today’s post summarizes the key economic effects. These will make the emerging changes a little more difficult to spot and the process will take a little longer. I study the partial Great Rotation portfolio (about 50% invested) to track market reactions. The results were mixed this week. I continue to proceed cautiously, mostly because there is no real rush.
Watch out for
- Lyft (LYFT). Not a viable long-term investment concludes Stone Fox Capital.
- Walmart (WMT), announcing earnings Tuesday morning. Brian Gilmartin explains why he is concerned about valuation.
- Stock sectors with the greatest impact from the coronavirus. Barron’s warns about Consumer stocks, industrials, and technology – naming some specific examples.
I wrote a brief spotlight paper on housing in September, which I offered to readers at no charge. I covered the following:
- Which indicators to use. Hint: Not prices, and not Case-Shiller.
- Attractive mortgage rates.
- Demographic changes – more buyers coming. Calculated Risk has a relevant update showing why the level of immigration is also an important consideration.
Pressure on immigration is a drag on the outlook and also on the economy. It is something to watch closely.
One element of my conclusion was the value in choosing companies that understood the market and adjusted their offerings. I mentioned two homebuilder stocks, saying the upside was 60% or more. This required merely a change in sentiment, not the fundamentals. The stocks have risen 35% and 40% in five months, but I still own them. I see more to come.
With some creativity readers can think of related stocks that benefit from home sales – renovations, furniture, appliances, and more.
With parts of the market becoming very expensive, this kind of analysis is becoming more important.
Finding sectors that are improving but still have room to run is a proven strategy that fits the times.
Great Rotation Hint of the Week
I’m getting reader questions about the Great Rotation. I have described the themes for several months, but there are always some new readers. I am using this approach in a few client accounts as well as my own. I am excited about it. It is not yet an official program for my firm, but I hope it will be soon.
Until then readers can opt-in to an email list which describes our progress with the design of the program, provides detail on the themes, and analyzes a specific stock we have already purchased. There is no charge and no obligation for participants, and we will not use your email for any other purpose. You can opt-out whenever you wish, but I hope you don’t! Comments and reactions are an important part of my investment process. I welcome your participation. Just write to info at inclineia dot com]. You might also want to request my September housing paper for more analysis on today’s theme.
Some other items on my radar
- Labor market tightening, which is ultimately inflationary. Nomura’s projection of the Fed’s favorite measure, Core PCE, shows the 2% target breached within the year.
- Secondary and tertiary effects of the coronavirus. So far, we have estimates of a modest economic hit, but these are early forecasts.