The calendar is massive, and it comes at a crucial time.
I have never seen so much fresh information in a single week: the biggest economic reports, the heart of earnings season, and an FOMC meeting. And that is without any Washington surprises.
It is a week where we should be paying special attention. Even though the pundits will report story-by-story, astute investors should wonder:
What can we learn from this avalanche of new evidence?
Last Week Recap
In last week’s installment of WTWA, I asked why the market was so quiet, reviewing several possibilities. This was indeed a topic of significant discussion during another quiet week. Also, as I predicted, some jumped on the idea of a lull before the storm. As I wrote on Twitter, if you seek omens, you will find them!
One example was some research highlighted by one of our favorite sources, Josh Brown. He featured an award-winning paper about forecasting a volatility tsunami. First the author explains:
In the paper, I discuss the common volatility environment of dispersion (think standard deviation) becoming very low ahead of many eventual spikes higher in the VIX(NYSEARCA:VXXB). While not every period of low volatility dispersion precedes a major move higher in volatility, most previous spikes we’ve experienced in the last ten or so years have followed a steep decline in volatility standard deviation.
[Jeff – I am struggling to see how expecting mean reversion from an extreme level is helpful. It is especially difficult when it has happened some of the time in the last ten years. I guess that means we should not be surprised if it does not happen again right now].
And then the author concludes about the current measures:
This tells us that it’s not just the large cap S&P 500 stocks that are experiencing a degree of over-confidence as expressed by the Volatility Index, but also the other major U.S. equity indices as well.
[Jeff — As I explained last week, stocks do not experience human feelings. A balanced market means that the aggregated demand and supply from millions of investors are in balance. Maybe Josh would consider an op-ed piece on this issue].
Another came from Fortune, a favorite source for wealthy investors. The authors describe five numbers to watch to spot the next recession. The lede and the emphasis is on the length of time since the last recession, “soaring” market volatility, and market highs. No wonder people are scared witless (TM OldProf). There is no economic support for the indicators cited, nor any record of success in such forecasts. It is disappointing that the magazine did not make an effort to find those with long-term success records on this subject.
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, who packs a lot of relevant information into the weekly chart without sacrificing clarity.
In another quiet week, the market gained 1.2%, most of it in a single day. The trading range was only 1.5%. As always, our indicator snapshot in the quant section below summarizes volatility and the VIX index in various time frames.
Another way to consider the volatility is by checking out the number of days with a change of more than one percent. 2017 was so abnormally low that it seemed to change expectations. 2019 is on pace to be another low-volatility year, including some weeks with hardly any change.
I will be at a conference in Scottsdale for the next few days. If any readers in that area would like to meet, please send me a message. It is a crowded schedule, but there are some gaps. I also look forward to seeing some of those I regularly cite in these posts.
Those who share my views on pseudo-experts will enjoy this article. Researchers looked for “the ability to play the expert without being one.”
Study participants were asked to assess their knowledge of 16 math topics on a five-point scale ranging from “never heard of it” to “know it well, understand the concept.” Crucially, three of those topics were complete fabrications: “proper numbers,” “subjunctive scaling” and “declarative fractions.” Those who said they were knowledgeable about the fictitious topics were categorized as BSers.
Read the full article for some surprising findings, and some that you might expect. Here is one on English-speaking countries.
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!
When relevant, I include expectations (E) and the prior reading (P).
New Deal Democrat’s high frequency indicators are an important part of our regular research. Indicators in all time frames have turned positive, some only marginally. NDD’s working hypothesis remains that we are seeing a rebound from a “mini-recession” from the government shutdown. He will not be convinced of the rebound’s prospects without more data.
- New homes sales for March were 692K (SAAR), better than E 655K and P 662K. Calculated Risk calls it a “solid start” to the year and expects the gap between existing home sales (affected by foreclosures) and new home sales to continue to decline.
- Durable goods orders for March increased 2.7%, solidly beating expectations of 0.9% and February’s decline of -1.1% (revised up from -1.6%). I always take note when an increase is in addition to an upwardly revised prior value. (MarketWatch). This is an important read on business investment.
- Mortgage delinquency rates decreased in March – down 5.3% compared to February and 2.0% year-over year. (Calculated Risk).
- Q1 earnings surpassed expectations on nearly all metrics. The earnings decline for the quarter has decreased to -2.3%, from -3.9% last week. Revenue growth is now 5.1%. These are both beating expectations by more than the five-year average. (FactSet).
- Michigan consumer sentiment improved to 97.2, slightly better than E 96.7 and P 96.9.
Q1 GDP surprised with a gain of 3.2% versus expectations of 1.9% and last P of 2.2%. News shows and political leaders celebrated the headline number (NYT), but markets were fussier. Chief among these was the increase in inventory accumulation (contributing over one percent) and reduced imports (which were affected by potential tariff timing). Without these effects economic growth was only 1.5%. (Barron’s). Despite the news stories, stocks did not rally on the news and interest rates actually moved lower. I enjoyed lunch with Bob Dieli on Thursday, and this scenario was just as he predicted. His subscribers can see the details. This left me well-prepared for an early analysis at FATrader. The story was pretty well reported on Twitter and financial media.
New Deal Democrat had a slightly different negative take, emphasizing his long-leading indicators in the report.
“Davidson” (via Todd Sullivan) suggests looking at trends in Real Private GDP. This takes out some artificial government accounting and provides a measure on private activity. He concludes:
But, the data reveals that an expansion in the Private economic activity the past 18mos has definitely accelerated. The Real Trailing Twelve Mos Private GDP is definitely significantly higher than the trend of 3.00% since early 2009. Today’s report of 3.51% confirms all other economic trends I monitor and is something expected in GDP data.
The development of Real Private GDP is to remove the skewed perception many derive from the widely reported and in my view misinformed GDP data. GDP includes discretionary govt spending which comes from taxation and govt borrowings based on the Private economy. It is a form of double counting the underlying strength or weakness when govt spending tends to rise and fall somewhat along economic trends. Total Govt Expenditure&Inv does not include the mandatory payments from Social Security or Medicare and etc.
This chart shows the significance.
And by the way, the Chemical activity barometer increased again in April (Calculated Risk).
I am scoring GDP as “good,” but it is really more of a neutral call by my rules.
And last but not least is this comment from Robert Dieli’s special GDP report (subscribers only).
All of the remarks you are seeing about whether this report indicates the start of a recession are a waste of your time. For two reasons. The first, and the most important, is that GDP in not used to in the establishment of business cycle peaks and troughs. The second, is you will find positive growth quarters in recessions. So, folks who try to date recessions with GDP don’t know the first thing about dating recessions.
- Existing home sales for March were only 5.21 M (SAAR) versus E 5.37 M and P 5.48M. Calculated Risk sees the level as “somewhat reasonable” and not worrisome.
- Initial jobless claims spiked to 230K, more than the expected 215K and much higher than the prior week’s 193K.
- Mortgage applications declined -7.3%. P -3.5%.
Sri Lankan terrorist attacks.
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.
We have a huge calendar – as much information in a single week as I have ever seen. It comes as a crucial time, with many investors worried about a market top that they fear might not be justified by the fundamentals. For these reasons I am taking a more detailed look at the calendar, putting it into perspective.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The massive calendar includes almost every important report in a single week. It is also the peak of the earnings season. And of course, we have an FOMC meeting. The data avalanche does not necessarily imply volatility. We often see offsetting reports or interpretations, leading to little change in markets. That said, the potential is there if the weight of the evidence nudges the aggregate of investor perceptions in one direction.
My guess is that the financial media will cover this week in a piecemeal fashion, without a unifying theme. What the punditry should be asking is:
What will we learn from the avalanche of new evidence?
I will split this into three sections – current, future, and what to watch this week.
Investor sentiment is neutral, and “surging” reports Bespoke.
David Templeton (HORAN) sees this as a sign of an indecisive investor.
Industrial sentiment is less fearful (Corbin Industrial Sentiment Survey). There is a lot of detail in this report, so read if you wish. I love the word cloud approach to a visual capture of changing concerns. Note the increase in green entries and the changes in the red ones.
Money managers remain cautious – even the bullish ones. (Barron’s)
Recent worries have been resolved or reduced.
- Recession fears have abated after a spate of stories sparked by “yield curve rookies.” Fed expert Tim Duy’s most recent comment calls it the “non-recession watch.”
- The Fed is on hold.
- Corporate earnings are holding most of last year’s gains, and next year looks better.
- Brexit is on hold.
- Trade war concern is no longer a hot story.
- North Korea negotiations are not making the same headlines.
- The growth slowdown, inferred from rather scant data and projected to continue to a recession, seems to have found a bottom.
Downside risk, objectively analyzed, is lower than it was at the time of the prior market highs, in September of 2018. But risk remains.
Upside potential is much higher. In the absence of a recession, corporate earnings can support significant stock prices increases. Some are even mentioning a “melt up.” I don’t see that, but a measured increase to 3200 is certainly possible and 3400 could be a target in 2020. Some current stocks are significantly over-valued, but many are cheap and attractive.
The solid upside targets are consistent with a modest rate of economic growth – 2.5% or even a touch less. That is the base case.
Let’s consider the week ahead from the perspective of these possibilities.
- The FOMC meeting is very unlikely to reflect a change in policy, so be alert if it does. I don’t regard modest changes to current policy as very important, but the market is reacting aggressively in such cases. Here is a cheat sheet based upon recent FedSpeak.
- Personal Income and (March) and Spending (February) are key elements of the economic picture. We’re still catching up from the shutdown. Income is especially important.
- PCE price index. The core rate is the Fed favorite, so it is more important than other inflation indicators. If it remains low, the Fed will remain on hold.
- ISM manufacturing index is important as a near-contemporaneous read on an important sector. It has some leading qualities for employment. ISM non-manufacturing covers a wider range of businesses but has a shorter history. The historical relationships are a key to any inference about overall economic strength. Beware of dramatic reactions to a small change.
- Employment is a fundamental element in measuring economic strength. We crave this information so much that we are often uncritical about the data. I am equally interested in the ADP report and the “official” non-farm payroll report. They use different methods, and each contributes value.
- Corporate earnings should support the current economic picture, both in continued earnings beats and outlook.
- Housing data are less interesting. Case-Shiller prices are older and on a subset of the data. Pending sales are interesting, but less significant than the new home sales data. Construction spending is also of lesser importance.
Does the evidence support the base case of 2 – 2.5% growth? That should be the question for each report – not whether there is a small change from the prior month.
I have a few additional 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.
Short-term and long-term technical conditions continue at the most favorable level. Our fundamental indicators have remained bullish throughout the December decline and rebound. The C-Score reflects the increase in headline inflation, despite slight steeping in the yield curve. I am watching this closely, including analyzing signs of possible confirmation of higher recession odds. We remain well within the warning period.
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.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.
The C-Score remains in a lower range, which puts me on alert for confirming or disconfirming information. We should remember that the indicator is designed to provide advance warning. Stocks often rally significantly in the pre-recession period, but we will not cut it too close.
Here is the most recent update from Bob Dieli. With his permission, I am quoting from his subscriber report). (His real-time record is the best. Why didn’t Fortune interview him?)
The third task is the one I would like to take up here, and it has to do with forecast management. While I was in Austin I noticed that their weather forecasters engage in the same practice that the forecasters here use. Namely, when something bad is in prospect, always call for the worst because there is no penalty for missing high. In Chicago it is snow storms. If they forecast 6 inches and we get 4, no problem. If they forecast 4 inches and we get 6, big problem. In central Texas the concern is rainfall and flooding. So, they mention all the numbers at the top of the range, both in terms of areas that can be affected and the amount of rain. The storm that had them worked up when I was there, turned out not to be much of an event in Austin. It tracked north of the city and, fortunately, did not spawn any tornadoes. Why am I telling you this? Because I have noticed that it is now permissible, if not fashionable, to talk about a recession. And, I have also noticed the same forecasting bias that the weather people have. Namely, there is no penalty for missing on how deep the recession will be, how soon it will be here and how long it will last. My other reason for bringing this up is that I am starting to get questions asking me to comment on other forecasts. I usually decline those requests unless I have a lot of information about where the forecast came from. Too many “forecasts” are sales pitches. And I don’t comment about those. As we proceed through the Boom phase, I will endeavor to let you know of any reliable indications of us getting close to the Contraction phase. Right now, I don’t see anything other than Boom phase readings. But I am keeping an eye on several anecdotal sources to see if there is anything of note that has not yet shown up in the statistics.
Insight for Traders
Check out our weekly “Stock Exchange.” We combine links to important posts about trading, themes of current interest, and ideas from our trading models. Last week we followed up the WTWA theme by considering quiet markets from a trading perspective. Specifically, we asked traders whether they were creating “false narratives.” As always, we cited some great sources and discussed some recent picks from our trading models. With all of the models back in action, there are more trading ideas and interesting contrasts with a fundamental approach. Felix rated the top twenty stocks in the Russell 2000 and Oscar did the same for the most liquid ETFs. Pulling this altogether was our regular editor, Blue Harbinger.
Insight for Investors
Investors should embrace volatility. They should join my delight in a well-documented list of worries. As the worries (shutdown, Fed policy, trade) 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 the Fear & Greed Trader’s commentary on the most hated bull market. He begins by noting that the number one question being asked by financial advisors is whether the U.S. economy is overdue for a recession. He then observes:
After five years of sending a market message that has followed this Bull market to new highs year after year, I find myself very tired. That tired feeling is not about my message, it’s about dealing with all of the negativity produced and doled out along the way. It doesn’t matter what month it is, how far the S&P is off the highs or settling at support, there is ALWAYS a scenario assembled to tell investors why things are about to get worse.
Over the years, it has been a parade of “What if” scenarios that turns on the caution light to investors. Valuations are too high, the Russell is telling us something, global trade issues are not resolved, the Transports are sending a message, Bonds are telling investors they are wrong, you can’t trust the Fed, and on and on and on. They have ALL been wrong, and I grow even more tired from defending the same message, “Stay on board”.
His message, like mine, is less exciting and newsworthy. A new market high brings out a new round of forecasts of bad times ahead. The result?
Investors have been overly cautious during most of the bull market, and worried more about preserving capital than searching for opportunities. Individuals invested for “safe” fixed-income instead of equities, and institutions underweighted public equity for more expensive absolute return strategies.
Read the entire post to see his more positive scenario.
Brian Gilmartin explains the drivers behind Microsoft’s growth. He looks at current valuation and also expects that expected earnings will increase.
5 Stocks Buffett might buy if He Could. These are interesting ideas with market caps of about $10 billion. Not big enough!
Kirk Spano provides a thorough analysis of Your Debt-Free, Profitable First Solar (FSLR) Stock. He is enthusiastic about the growing attractiveness of solar energy but realistic about the challenges First Solar faces.
Scientific American explains industrial demand and the potential for carbon-free heat.
And don’t forget about the solar energy investment tax credit (ITC) which was renewed in last year’s tax package. Here is advice on how to earn and take it.
Short sellers target solar and alternative energy stocks. (24/7 Wall St.) Your interpretation of this depends on whether you think this is “smart money” or more as something that can fuel buying when covered.
Solar energy also plays prominently in Lyn Alden Schwartzer’s, India’s Achilles’ Heel. You might be surprised to learn that India may be the world’s most populous country by the mid-2020’s and also the second largest economy. Energy is crucial to reasonably priced growth, and Lyn provides some investment ideas.
William Stamm likes Philip Morris International (PMI). He sees good yield and a “recovering total return.”
Past Winners and Losers
How about a dogs of the S&P 500 strategy? Double Dividend Stocks suggests three high-yield candidates.
Or maybe some big earnings season winners which have “more upside ahead.” (Jon C. Ogg, 24/7 Wall St.)
Looking for biotech ideas?
Bhavneesh Sharma suggests Moderna Therapeutics: Potential to Disrupt a $200B+ market. He provides an understandable explanation of the significance of mRNA technology.
Moreover, unlike DNA-targeting therapeutics like gene therapy, which may produce permanent changes, mRNA therapy effects can be transient and limit the risk of irreversible changes to the cell’s DNA.
Abnormal Returns always provides interesting ideas on a wide variety of topics. I am a subscriber, and I read it daily. Each Wednesday’s edition includes a post focused on personal finance. This week I especially enjoyed Nick Maggiulli’s warning about a trap for financial advisors – linking it too much to their own experience. The post is clever, humorous, and wise. Here is the essence:
Now, of course, it is probably better to listen to a self-made rich person than a self-made poor person when it comes to financial matters. However, this doesn’t imply that the rich person understands how they got rich. It’s easy to come up with a story for how you earned your wealth after you earned it. It’s like shooting an arrow and then painting the bullseye.
How your cost of living changes with family size. (Conversable Economist).
Watch out for…
Verizon (VZ), which Stone Fox Capital sees as too expensive compared to AT&T (T) and without a near-term catalyst.
Your ETF choices. John Rekenthaler describes what happened when he invested in emerging markets on a general thesis rather than specific analysis. Many members of what everyone called an “asset class” simply disappeared. And the low correlation with US stocks proved deceptive. Please compare this with Lyn Alden Schwartzer’s approach, cited above.
I have been pondering the question of how so many investors get on the wrong track and stay there, despite continuing contrary evidence.
One problem is the constantly repeated assertion of an over-valued market with prestigious citations. I have occasionally written about the valuation question, but it seems to arouse the passion of so many that it can be annoying. Despite this, I have decided to try again, starting with a series on CAPE. In the first installment I demonstrate the problem with using data from 1871. It has distorted the entire picture.
I have many additional installments planned, including a few you have not heard in the prior debate on this topic.
I’ll also revisit the Hussman chart which no one can explain. (Many repeat what Dr. Hussman asserts but can’t explain what the lines mean).
If you have the world view that the market is in Wile E. Coyote territory, you are in constant fear. Since that has been wrong, your narrative is ever-changing: Fed policy threw things off, everyone is and remains foolish, valuation is not good for market timing, the forecast is not for the near term, but for five years, seven years, ten years, twelve years.
Here are two key questions:
- Do you intend to keep the same asset allocation for ten years? I certainly don’t and neither do my clients. We expect to adjust with conditions.
- Have you heard any earnings season discussion of CAPE for a stock? I have not. Stocks are evaluated on expected earnings. Everyone is trying to look ahead, so they do not consider the past ten years as indicative.
Why should we be surprised that CAPE forecasts are so bad at a time when conditions are getting better?
Are you ready to move quickly with new evidence? Do you need more dependable and less risky income investment income? Send an email to main at newarc dot com. We’ll provide some helpful free information, and at your option, a no-charge portfolio consultation when I return from my trip.
And also, some longer-term items on my radar
I’m more worried about:
- The ongoing drag from trade policy. I have called this a real-time lesson in economics, but the students are a bit slow. Timothy Taylor provides a good example of the effects, focused on washing machines.
- Post Mueller report politics. Needed compromises cannot happen with such intense partisanship. This includes the growing problem of government debt. The Bipartisan Policy Center provides the Social Security story in five charts. Here is one of them.
I’m less worried about
- Brexit. As is often the case, governments are reluctant to drive over a cliff. Deadlines are flexible. Some remain pessimistic that the needed political changes can be achieved. (CFR).
- Recession concerns, especially as we move past Q1 data and get some stability.