The economic calendar is a modest one featuring the JOLTS report and inflation data.
NFIB optimism and Michigan sentiment continue to be important since confidence is part of the current economic issue. The relative lack of economic news leaves plenty of time for the punditry to offer “explanations” for each 1% market move. The main competition will be the developing political stories. As I frequently emphasize, we should not base our investment decisions on our political views. That said, the savvy investor cannot ignore public policy. Elections and policy consequences can dramatic affect our investment choices. It is quite appropriate for us to wonder:
What does the changing political landscape mean for investors?
Last Week Recap
In my last installment of WTWA, two weeks ago, I discussed the recent additions to the wall of worry. In the Final Thought I offered suggestions about dealing with headline worries, the newest blocks in the wall. Both the topic and the advice held up well during the eventful two-week period.
Market participants seem to include a group that accepts the modest sub-2% growth as acceptable if there is no recession and another that expects aggressive Fed action.
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 Jill Mislinski’s version which combines a lot of useful information in a clear presentation.
The market lost only 0.3% for the week but what a ride! The trading range was 4.1%. The high came at Tuesday’s opening. The big declines came after the ISM manufacturing data on Tuesday morning and ISM services on Wednesday. You can monitor volatility9NYSEARCA;VXX), implied volatility, and historical comparisons in the Indicator Snapshot below.
From the many charts in Jill’s post, let’s enjoy one more – this perspective on drawdowns. When reading scary headlines and news bites like those we saw on Tuesday and Wednesday, it is good to keep this chart handy.
Personal Note – Move Nearly Complete
Our move included three segments – us, our car, and our furniture. Mrs. OldProf and I arrived on Tuesday and took possession of our new home. Our car was delivered on Wednesday. The furniture is scheduled for delivery on Tuesday. For the moment we remain at temporary lodgings in a Phoenix hotel.
Some readers have asked that I describe the investment aspect of our decision, but that would not be very helpful. Most of the factors were personal. Mrs. OldProf loved the area at first sight. Our home is in an active adult community with plenty of activities. It is in Peoria Arizona, named after Peoria Illinois. The population is about the same as Naperville, but the land area is four times the size. There are many wide open spaces and plenty of mountains in every direction.
Once again, we wish to thank readers for the many helpful suggestions and ideas.
The Visual Capitalist has some wonderful charts on the decline of confidence in American institutions. I cannot easily replicate these, so take a look at the great work. Here is some of the data in table form.
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. The results remain positive in all three of the time frames. The short-term indicators are volatile and the weakest, mostly reflecting the emphasis on manufacturing(NYSEARCA:XLI).
- Mortgage applications jumped 8.1% versus last week’s 10.1% decline.
- The employment situation report for September got good grades from most sources. The headline non-farm payroll gain of 136K was slightly lower than expectations of 150K but the prior number was revised up by 38K. The unemployment rate dropped to 3.5% beating expectations and August’s reading of 3.7%. The major drawback was that average hourly earnings were unchanged versus a forecast of a 0.3% gain.
- ISM Manufacturing for September declined to 47.8, weaker than August’s 49.1 and expectations of 50.2. The below 50 reading signals contraction in for manufacturing. Many people mistakenly believe that this signals a recession. I immediately wrote that the ISM’s own calculations showed that the reading, if annualized, corresponded to GDP growth of 1.5%. The reason is that manufacturing is a declining portion of the economy. The comments from the ISM provide some color – concerns about input costs, trade war impacts, tight labor markets, and overall uncertainty. Two day’s later Dr. Ed Yardeni made similar observations: No Recession in Purchasing Managers Report. Scott Grannis takes particular note of the tariff impact on the data.
- ADP private employment for September showed a gain of only 135K, lower than expectations of 150K. August’s gain was revised lower, from 195K to 157K.
- Factory orders for August declined 0.1% versus expectations of no change and July’s gain of 1.4%.
- ISM Non-Manufacturing for September registered 52.6, missing expectations of 55.4 and August’s 56.4. This was an echo of the manufacturing report, with an implied GDP growth rate of 1.4%.
Hong Kong protests and reactions. Fox News covers the face mask ban.
And also, Iraq protests. Over 100 have already died with no end in sight. (BBC).
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 calendar is a modest one featuring the PPI and CPI results and the JOLTS report. NFIB’s small business optimism index remains interesting, as does the Michigan sentiment survey.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The week ahead is light on economic data and heavy on breaking political news. Many of the stories will present a heavily biased viewpoint. While investors may find those sources entertaining, they are unlikely to be profitable.
I would rather directly discuss economics and markets, but sometimes political factors are the drivers of events. The realistic investor should do an objective analysis, asking:
What do the changes in the political landscape mean for my investments?
I feel a duty to take on this topic both because of the importance and my unusual combination of experiences. I taught American politics, Congress, and the Executive in my professor days. I also watched most of the Watergate hearings and followed the Clinton impeachment story. For over thirty years I have managed investments, often taking advantage of policy themes where markets were mistaken. I have found successful investments no matter which party has held power. To do this effectively you must maintain objectivity.
- When a policy is investor friendly, I describe that as such even though I might not personally like it.
- When a policy is dangerous for investors, I describe that regardless of my opinion.
If you read today’s post with these principles in mind, I think you will find it valuable.
I will look at the major current political themes, discuss the odds of various outcomes, the effects on the economy, and the likely effect on financial markets.
This chart is a helpful description of the impeachment process, which has now begun. It is part of an article providing additional background. (NOLA)
The process has already begun in the House, covering the first two points in the chart. The are already 225 announced supporters for impeachment, more than the 218 required. The process is likely to drag on as House investigators subpoena documents and witnesses and the Administration resists. Since the trigger for the recent shift in opinion was the Ukraine story, the Democrats will be looking for other similar incidents. (Axios with a whip count).
If the House votes to impeach, the Senate must conduct a trial. Majority Leader McConnell has already said that such a trial would not be prolonged. With the current partisan split in the Senate (52 GOP and 48 DEM) a conviction would require substantial Republican support to reach a 2/3 majority.
Here is the current division of popular support, broken down by party.
There is a very wide range of possible outcomes, including 5 Ways Impeachment Could Play Out.
So far, financial markets have shrugged off the impeachment news. The two likely explanations? Few expect the process to lead to removal from office. If it did, replacement by VP Pence would probably not lead to unfavorable policy changes.
The biggest impact so far has been a heightened level of partisanship. Since much of the Trump program has been achieved by uncontested Executive Orders or has already been passed, a stalemate has a more limited effect. Infrastructure legislation is unlikely before the 2020 election. The USMCA (NAFTA 2.0) will be an interesting test. Sources are divided on the post-impeachment prospects for this important legislation.
The fast-changing landscape affected the nomination odds. I am using Predict-It, although there are several other betting markets. These should be viewed only as indications, since the markets are sometimes very wide and the volumes low.
Sen. Warren took the lead in these markets in September, but recent events gave her an additional boost. The Ukraine story seems to be hurting Biden. Sen. Sanders’ health issues have further reduced his chances. Expectations are that much of his support will move to Warren.
Normally the nomination of a sitting president for an additional term would be a slam dunk. That is not the case this year, as this chart shows. The Ukraine and/or impeachment stories have had some effect.
Rightly or wrongly, the investment community strongly favors Republican candidates. There are special worries about Sen. Warren’s policies, especially the wealth tax and Medicare for all. Floor veteran Art Cashin is our best sounding board for opinion on the NYSE. He opined that 200-300 points in Wednesday’s DJIA decline were a result of the Sanders story.
On Wednesday I suggested that the political tail was wagging the dog. Here is the “parlay” of events needed to enact the feared policies:
- Trump is the GOP nominee (now down to 70% or so)
- Warren becomes the Dem nominee — now a little over 50%.
- Dems reach 60 votes in the Senate (to block) filibusters — very remote.
- Something like Medicare for all gets enough traction to become law, despite the Senate obstacles.
Markets frequently over-react to minor changes in the election story. As everyone knows, the policy results often differ significantly from the election promises.
I’ll have some additional observations 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.
Short-term technicals have weakened over the last two weeks and are now close to the highly bearish range. Long-term technicals remain neutral, but are also weaker. Recession risk is still in the “watchful” area. We are seeing little confirmation for the risk signals, which we have been monitoring since May.
Considering all factors, my overall outlook for investors remains bullish.
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.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. Especially helpful is the regular update of the Big Four indicators used by the NBER in recession dating.
The pattern of increases continues. A recession is called when there is a substantial decline from peak levels. Let’s take a look at where the indicators stand versus the highs.
Scott Grannis debunks the “stall speed” argument, noting the many times it has been incorrectly advanced over the last eight years. His conclusion?
As I put it in a post three years ago, “recessions typically follow periods of excesses—e.g., soaring home prices, rising inflation, widespread optimism—rather than periods dominated by risk aversion such as we have today.” It’s not slow growth that precipitates a recession, it’s too much risk-taking and too much optimism that eventually collide with the reality of tight money. Recessions happen when the future proves to be radically different—in a bad way—than it was presumed to be, and people are thus forced to do an about-face.
Today, risk aversion is just as abundant, or even more so, than it was in the latter half of 2015.
James Picerno surveys the indicators and remains uncertain about recession odds.
There’s No Recession Coming. The Fed Will Make Sure of That. (Barron’s, October 4th).
Federal Reserve Interest Rate Cuts Alone Can’t Prevent a Recession (Barron’s, October 4th).
One of the authors will be incorrect, but the publication has it covered either way!
Insight for Traders
Our weekly “Stock Exchange” series is written for traders. I try to separate this from the regular investor advice in WTWA. There is often something interesting for investors, but keep in mind that the trades described are certainly not suitable for everyone.
This week’s edition discusses how market-weighted ETFs have created a concentration of assets in a small number of stocks. Is it dangerous? And what reaction might traders have to this development. As always, we share some picks including ideas from our new member, Emerald Bay. Pulling it all together and providing counterpoint drawn from fundamental analysis is our regular series editor, Blue Harbinger.
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 Warren Buffett: The Price Of A Stock Doesn’t Tell You Anything About The Business by Johnny Hopkins. Drawing upon “Adam Smith’s” interview with Warren Buffett he highlights the following:
The real test of whether you’re investing, from a value standpoint or not, is whether you care whether the stock market is open tomorrow. If you’re making a good investment in a security it shouldn’t bother you if they closed down the stock market for five years.”
All the ticker tells me is the price. And I can look at the price occasionally to see whether the price is outlandishly cheap or outlandishly high but prices don’t tell me anything about a business. Business figures themselves tell me something about a business but the price of a stock doesn’t tell me anything about a business. I would rather value a stock or a business first and not even know the price. So that I’m not influenced by the price in establishing my valuation and then look at the price later to see whether it’s way out of line with what my value is.
[Jeff] If I had to pick one thing to help the long-term investor, this would be it. Since evaluating companies is difficult, most cannot do it. Anyone can look up past price history. The result is that people do what they can and believe it is important research. In fact, the psychological need to have regular reassurance from Mr. Market is a costly mistake.
Chuck Carnevale joins me in my endorsement of Safal Niveshak’s article, Why Value Investing Works. Chuck begins with the original article and really takes off with it. I especially liked this comment:
The essential principle that I am attempting to convey is that value investing only works when the underlying business is creating value. In other words, being cheap and having value are not always the same. This is precisely why solely relying on metrics such as P/E ratios or any other multiple of any other fundamental metric can be dangerous and misleading.
As usual, he provides excellent contrasting illustrations for this point.
Blue Harbinger features the preferred shares of Tsakos Energy Navigation Limited (TNP). As usual, the article examines the balance sheet, the safety of the dividend, the business model, and the inherent volatility of the energy transportation business.
Interested in biotech? Barron’s (last week’s issue) has a nice expert roundtable with plenty of good ideas.
Abnormal Returns is the go-to source for anyone serious about the investment business. The Wednesday edition has a special focus on personal finance, with plenty of ideas for the individual investor. As always there are many good links, especially related to Social Security misconceptions. I especially enjoyed Mark Miller’s Morningstar post on how Social Security helps to provide some inflation protection.
Watch out for…
The crowded dollar trade. Lyn Alden Schwartzer carefully explains why this trade must eventually come to an end and evaluates possible scenarios. The article will be of special interest to those following long-term government debt issues. (And if you are not, you should be!)
Retiree scams. Barron’s has tips on how to avoid or to handle the common ploys unknown to most potential victims. I mentioned that this would be a good ice-breaker at our new club in the senior community. Mrs. OldProf observed that I would be well advised to wait until I know people a little better. Maybe there is a newsletter or something. As a colleague recently observed, “That Mrs. OldProf is very wise.”
The impeachment and election stories have replaced the former focus on the most important economic and market issue: The trade wars.
Some readers have objected that I have been completely wrong in my prediction of a trade resolution between the US and China. I expected the following:
- An agreement would take a long time to achieve.
- It would not be comprehensive – too difficult and complicated.
- Progress would occur in stages, beginning with a partial truce and some general principles for further negotiation.
- An agreement would include face-saving provisions for both sides.
- The pressure to agree would be driven by the desire for a win-win solution.
- The Trump Administration would feel pressure from GOP leaders and donors, especially as the effects on their constituents became obvious.
So far, I have been accurate on points #1 and #6. Pressure has shifted Trump policy on Mexico and Huawei, mostly the result of quiet insistence from GOP sources.
Presidential elections usually depend on the economy and war. A leader who avoids a shooting war and presides over a strong economy has a strong chance of reelection. President Trump could fix the economic problems with a few strokes of his pen. Blaming economic problems on the Fed or the impeachment process may play well to his base but has nothing to do with actual recession odds. I am sure he is hearing this from advisors, but disagreement with the President seems to be a career-shortening move.
The Great Rotation Continues, but At What Speed?
As recognition of the dangerous and crowded trades increases, long-term investors have plenty of inexpensive alternatives. The biggest drag comes from exaggerated recession fears, which we saw in December and again this week. If the employment report had been weaker, easily possible when the confidence interval is over 100K, we would have seen many stories on how this confirmed the ISM numbers. These moves continue to represent opportunities.
The ‘Fear Trade’ Is Getting Crowded. Going the Other Way Could Pay Off. Avi Salzman includes this key observation:
Wells Fargo analyst Christopher Harvey argues that portfolio managers are “trading scared,” leading to a pileup in low-volatility stocks. The consensus among investors seems to be that interest rates will fall, the world will slide into recession, and stocks with exposure to China are particularly vulnerable.
“The outperformance of S&P 500 Low Volatility Index (+19.5% vs. SPX +4.2% as of 9/30) matches its 2008 outperformance—suggesting investors are already in a ‘cash-and-canned goods’ mentality,” he wrote in a Friday research note.
The opposite of that is betting on a reflation in rates, stabilizing-to-improving growth, and a resolution to the U.S.-China trade war—what Harvey calls the “pain trade.” And because it’s so out of favor, it could actually rise into year end.
My focus on the trade war reflects the importance of this issue. A resolution would lead to lower input costs, less consumer inflation, better profits, improved business and consumer confidence, and a general change in expectations. Some of the effect would be immediate. Some will play out over time as the effects become clear in the data.
[If your portfolio is loaded with crowded trades, it might be time for a change. Write for my free sector spotlight paper on housing, currently my favorite sector. You will get some ideas about replacing over-valued stocks with those showing great potential. After I settle in to my new digs, I will resume portfolio consultations – complimentary and without obligation. Just send an email request to info at inclineia dot com].
Some other items on my radar
I’m more worried about:
- Escalation in Hong Kong. If there is a heavy-handed Chinese response, it will be perceived as a challenge to the US as well.
- Polarization in the U.S. Particularly disturbing is this article: Armed Militias Are Taking Trump’s Civil War Tweets Seriously.
I’m less worried about
- The GM strike. It was on my list of greater worries, but there seems to be encouraging news this weekend. A strike could ripple through the economy.
- October. Paul Schatz takes a look at the numbers.