We have a normal economic calendar. Tuesday’s election will take center stage.
Markets have less than expected interest in the election. Partly this reflects confidence in a split outcome, with no major policy changes.
I expect pundits, especially if encouraged by early-week trading, to focus on the signals from volatility (NYSEARCA:VXX)and markets declining below technical support. Many will be asking:
How should we react to these storm warnings?
Last Week Recap
In my last edition of WTWA I guessed that the punditry would move away from daily attempts to interpret market moves and look more closely at the upcoming mid-term elections. That was mostly wrong. There was enough daily volatility to maintain media attention. There were some stories on the election, but mostly of the “horse race” variety, not material very useful for investors.
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 the futures chart from Investing.com. The image posted here shows a static view. If you go to the site, you can check out the news at various points during the week and adjust the view in many other ways. Since futures trade when the stock market is closed, you can also see those moves.
The market gained 2.7% and the weekly trading range was 5.8%. Both were extremely high. I summarize actual and implied volatility each week in our Indicator Snapshot section below.
Congratulations to Josh Brown on his tenth blogging anniversary! Readers of “A Dash” are familiar with him as a source I frequently cite. Josh has a special role as a blogger committed to the interests of individual investors. I reviewed his first book (here) in January 2013 and noted the strengths of both has blog and his book. His traits are a guide for would-be-bloggers. They would need his honesty, talent, and ideas. Here is a conclusion from my review:
In our office we give Josh our highest accolade: We “unmute” the TV and back up the TIVO to hear what he has to say.
I have also frequently recognized him as a winner of the Silver Bullet award – taking an unpopular position that helps people see through the smog of bogus contentions.
Please read Josh’s eloquent post about what his writing has meant to him – especially the importance of readers and supporters. As one who has shared many of these experiences, I have a special appreciation for his comments. I have the same feelings toward my readers, supporters, and friends. You really cannot make it as a writer without this kind of encouragement.
I wish Josh another ten years and more!
[I have never spoken with Josh in person or on the phone. He is a blogging and email friend, but one who makes readers and correspondents quickly feel a personal connection.]
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 week reflects some improvement in his regular three time frames, although long-leading indicators remain neutral.
When relevant, I include expectations (E) and the prior reading (P).
- Earnings season continues to show strength. Brian Gilmartin notes that S&P 500 earnings yield has been above 6% for three straight weeks. This has not happened for almost three years. While many look at earnings or revenue beats and misses, most probably have not watched data on profit margins. Would it surprise you to learn that these were improving? (FactSet).
- Factory orders increased 0.7% in September. E 0.4% P 2.6%.
- Hotel occupancy continues to increase at a record pace (Calculated Risk).
- Consumer confidence from the Conference Board was 137.9 E 135.8 P 135.3. (Jill Mislinski). Here is the best consumer confidence chart, showing many key elements in a single view.
Employment showed strong growth. The WSJ had a good chart pack for “employment Friday.” The only negative for these numbers was the “good news is bad news” argument, that the Fed will proceed with the planned rate hikes.
- ADP private employment showed a gain of 227K for October. E 190K P 180K. (See Jill Mislinski for analysis and multiple charts).
- Initial jobless claims were only 214K. E 213K P 216K.
- Payroll employment registered a net increase of 250K. E 190K P 118K revised from 134K.
- Unemployment remained at 3.7%.
- Labor force data also encouraged.
- Construction (NYSEARCA:XHB) spending for September showed no gain. E 0.2% P 0.8% revised from 0.1%. (Big revisions like this make the most recent result more challenging to interpret).
- ISM manufacturing(NYSEARCA:XLI) for October registered 57.7. E 59.0 P59.8.
Personal income for September increased 0.2%. E 0.4% P 0.4% revised from 0.3%. (Another revision effect; probably best to consider the two-month total). Personal spending was up 0.4%, in line with expectations. The Capital Spectator wonders, Has the Rebound in Consumer Spending and Income Peaked?
James Picerno writes:
True, the latest annual increases still align with a healthy trend, which suggests that the nine-year-old economic expansion will roll on for the near term. But yesterday’s results add more weight to the view that the Trump rebound has run its course and that something approximating a “normal” rate of growth – read slower – is coming.
- PCE prices were up 0.2% on the core. 0.1% E 0.0% P. The headline number was 0.1% as expected, but the core level is the favorite Fed inflation measure. Jill Mislinski provides analysis and this helpful comparison chart.
The campaign. It is everywhere and seems different from past elections. Intensity of feeling and expression is high. Those whose minds are made up grasp at any statement as confirmation of their viewpoint. Facts are in short supply. The “undecided” are the chief targets of the avalanche of negative advertising and the record campaign spending. I ventured onto Facebook (which I use only for personal and family matters) and was amazed by what I read from friends and relatives.
The only upside I see is that many of these people invest, so our “poker table” has an abundant supply of losers.
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 normal in significance. ISM services is an important and early economic read. JOLTS is somewhat trailing data, but the best indicator of labor market structure. We’ll get the FOMC rate decision, which will not surprise anyone. Earnings reports continue but are winding down a bit.
The election results will take center stage.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
It will require a major surprise for a market reaction to the election. Until there is more clarity, I expect the punditry to focus on the volatility and trends in stocks, with an emphasis on whether investors should be afraid.
Expect many to be asking:
What should we make of these storm warnings?
This will be especially true if we get an early-week decline in stocks.
Many are jumping on this theme. If we rounded up the usual subjects, we would find bond guys, insurance guys, page-view guys, and horror film producers. I read them all because it is my job to be aware of all viewpoints. Unless you know how to cut through some persuasive but deceptive arguments on your own, just save some time. Do something with your family. (Mrs. OldProf recommends watching and cheering for the Packers on SNF, where she is expecting a big upset).
Readers seem to appreciate some intermingling of current arguments with my comments in cases where there is an important counter argument. I’ll put my thoughts in italics. While data-based, these represent my own conclusions. I act on them, but you should make your own decisions!
Look Out Below – There’s More to Come!
Pundits in this camp see the recent stock declines as support for an enduring bearish thesis, be it valuation, spotting bubbles, or technical breakdowns. You can throw in finding conspiracies and general distrust of any institution.
[These sources are pervasive, so you don’t need my help in finding them. They get high visibility in mainstream media. I am sorry that the battle for survival has become a battle for page views. To assist me in following this flow I have created a Twitter list for “reliably bearish commentary.” I do not recommend following the list, but you should consider following me! https://twitter.com/dashofinsight I have a few other lists that might interest you]. I am up to over 4600 followers. My old academic friends are impressed but consider this: Someone named Kim has 59 million followers, and this source has built two million in 18 months, always keeping it short and sweet:
As I said, the investment poker table is loaded with opportunity].
Support has been broken
Many other technical sources agree – as do we! If you look at the indicator snapshot, we are seeing the same signals as others, even though we all use somewhat different methods.
[ I use technical methods in all our trading models. I certainly look for support when establishing new positions. I have little confidence in these current signals. I (and my team) closely watch the market. Usually there are bogus explanations for small moves that are merely noise. This week revealed quite a difference. Relatively significant intra-day moves (over 1% in a few minutres) quickly followed stories about trade. Friday was the best example. Pre-opening there was a Bloomberg story that Trump had asked his team to work on final language for a China deal. This was consistent with his own early-week assertion of a personal talk and real progress. Before the opening, CNBC’s John Harwood reported a meeting with Larry Kudlow where this story was denied. Later in the day, there were more stories about plans for a face-to-face meeting at the G20. There was no real trade news, beyond these vague rumors. The employment data were secondary, because the good news was bad news for some. Here is the daily futures chart so you can see the pre-market trading.
The pattern is a tweet or vague story, a reaction by algorithms, a further reaction by traders, (sometimes) a reaction by those looking at technical indicators, and finally, a media “blessing” and “explanation” of what happened.
Let’s keep in mind the history of potentially market-moving tweets. From Barry Ritholtz:
Do you want to base your investing on tweeting, extended machine moves, breaking “support,” and silly pundit comments?]
The Economy is Rolling Over
This is a popular theme and we can expect to hear more stories like this. The basic concept is that some economic indicators are “decelerating.” You can draw a line and put a round red circle on the top to illustrate.
My (blogging) friend New Deal Democrat sees an economic decline. He looks beyond the headline ISM report to check out new orders, which he notes are 57.7. His line in the sand on new orders is 60. See also his “Housing has Peaked.”
The James Picerno take on personal income (above) has a similar orientation – an OK result, but worse than before.
We should expect to see an avalanche of stories like this. Something is “decelerating.” We have a “growth recession.” Growth is slowing. These stories will all be true – factually accurate. They will also be misleading.
[This has been popping up on WTWA for some time, and I have tried to highlight it. Economic results cannot improve forever. There is an important difference between “declining” and “decelerating”. Growth cannot continue forever at a breakneck pace. It is possible to decelerate to a level of growth that is solid and sustainable. No one ever talks about this, since it does not work well in a headline. Everyone is itching to lead on forecasting the next economic decline.
Consider the data – always a good idea! David Templeton (HORAN) highlights a list of solid indicators, describing the deviation from current sentiment.
Imagine a perfect investment world. What would be the level for each indicator? My guess is that you are choosing levels reflecting less growth than we have now. This would be a good future topic].
I have included most of my key ideas, but the Final Thought will focus on what it means for investors.
We follow some regular featured sources and the best other quant news from the week.
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.
The Indicator Snapshot
Short-term trading conditions have continued at our highest alert stage. The identification as “very bearish” is a reaction to volatility, not a prediciton of a continued decline. There is always a risk/reward balance to consider in your trading. When conditions are technically challenged, we watch trading positions even more closely. Each of our models has a specific exit strategy. The technical health rating may drop enough for a complete trading exit. It got close to that level this week, and remains there.
Long-term trading has also moved to the “high alert” stage on a technical basis. Why is the outlook “neutral?” Fundamental analysis remains strongly bullish. Earnings are great, prices are lower, and there is even less competition from bonds. We reduce fundamental positions (as we did in 2011) when we get a warning from the recession or financial stress indicators, not merely as a reaction to technical signals.
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.
Recessions require two elements:
- For these indicators to peak
- For them to pull back significantly from the peak.
Those who assert that a recession has already begun should have the pundit license revoked!
Insight for Traders
Check out our weekly Stock Exchange post. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we asked traders: Do you exit trades when conditions get risky? This was a good follow up to the prior week analysis of falling stocks. Using a stop loss and analyzing risk are two quite different approaches. As usual, we also shared advice by top trading experts and discussed some recent picks from our trading models. Our ringleader and editor, Blue Harbinger, provided fundamental counterpoint for the models, all of which are technically-based.
Insight for Investors
Investors should have a long-term horizon. They can often exploit trading volatility.
Best of the Week
If I had to pick a single most important source for investors to read this week it would be Dr. Brett Steenbarger’s discussion of market psychology. While ostensibly directed to traders, this is crucial information for investors as well. Knowing the trader thought process might well provide a calming influence. Here is a good quotation:
In recent sessions, we have seen buyers come into the market, as we can see by the two-hour measure going into positive territory, but note that they are not “getting it done”. The buying bursts, mostly short-covering, are able to retrace only a relatively modest fraction of the prior price decline. At some point–and I’m prepared for it to come soon–the selling pressure will have trouble making new lows and buyers will step in more aggressively, with higher $TICK readings. That is how bottoming processes begin.
This includes excellent analysis of key indicators. If you are a trader, you should sit up and take notice. If you are an investor, you might choose to be wary of daily market moves (and the explanations on the nightly news) that reflect these actions. Does this market really have a message for you?
He also describes Peter Lynch’s six stock categories which are a useful part of developing a balanced portfolio. He also provides examples for each category. Readers will learn about building a portfolio while also getting plenty of ideas. Plan to spend some time, studying this article carefully.
Continuing my series on boosting your dividend yield, I took up the case of AT&T (T). This is a good approach for those whose principal need is income.
Interested in tech stocks? Want to collect dividends? Kirk Spano shows how you can do both with 5 Dividend Growth Tech Stocks to Buy Now.
Amazon? (AMZN) Now is the time to buy. (Tae Kim, Barron’s)
Even if your portfolio has done well this year, you probably have some losers. Morningstar explains how tax loss selling can provide something of a “silver lining” for those with taxable accounts.
Another Financial Crisis?
Focus Economics invited forecasts from 26 of the “World’s Leading Economists.” This article has many good ideas and is worth your consideration. I am delighted to be included in this elite group.
Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Each week he highlights stories of interest for both advisors and investors. He also provides insightful commentary on important topics. Be prepared for something that cuts against the grain!
My favorite this week was his report of former Fed Chair Janet Yellen at the Schwab Impact conference. Her keynote took up the question of America’s growing debt problem and her approach to a solution: raising taxes and cutting retirement spending. Gil adds his own analysis:
How do we provide financial security that is adequate for individual retirees yet sustainable for the government – specifically in the context of a fairly rapidly aging population based on increasing longevity and slower family formation among the young? The problem is worsened by the cultural reality of debt-financed consumer spending.
Many possible solutions are essentially “closed doors” from a political or cultural point of view. Immigration is politically unpopular, and neither are big families “in” these days. Given high household debt, cutting retirement as Yellen suggests would severely impact all but the wealthiest households and higher taxes always risk suppressing economic growth and job formation.
I think there’s an additional political problem, which is the lack of political consensus. The U.S. switches every few years from tax hikes to tax cuts, leaving little chance for consistent policy to take root.
Read the full post for his challenging solution – or at least the start of one.
Abnormal Returns is an important daily source for all of us following investment news. His Wednesday Personal Finance Post is especially helpful for individual investors. As always, there are several great choices. I especially liked The Belle Curve on the effect of using calendar years as a measure for investment performance. She provides an interesting example showing the psychological effect of different return paths. Also – those preparing for college spending should read this post about 529 plans.
I always enjoy it when Tadas has the opportunity to develop his own theme on a topic. This week he describes what he calls “the cash addiction problem” of those who have “a big slug of cash” but are not even considering investing it. I hope this sounds familiar to WTWA readers. It is always reassuring to be on the same team with Tadas.
Talking Biz News highlights a new personal finance site from Investing.com, Allrates.com. There are many interesting articles and resources. This is a good one to add to your bookmarks and check out when you have key questions.
Watch out for…
Starbucks (SBUX). Stone Fox Capital is concerned about margin compression.
Junk bond funds. (Barron’s). Read the article to learn about the CCCrash. [Jeff – The lowest-quality bonds offer stock-like risk with a lower return.]
Morningstar’s Halloween post highlights 10 Scary Stocks which are over-valued according to their methods. (Our Athena model owns one of them!) Check out the full post for the reasons behind this list.
How should we react to the storm warnings?
It is not a good market for trading. Unless you can complete with HFT algorithms, you have a problem. You must either find a different approach and/or time frame, or step aside.
If you are an individual investor, it is quite different. Let’s consider each of the two major warning signals.
- High volatility. Research shows that VIX is mostly a coincident indicator. When it spikes, it is related to gains in the 1, 5, and 20 trading day time frames. (Bandelli and Wang). This is consistent with results I reported last week.
- Intense selling. Mike Williams has a very nice treatment of fear and market reaction. Here is the current Merrill indicator.
And here is the flow of funds to the Rydex Bearish Fund.
His backtest shows the following:
This relative flow into inverse Rydex mutual funds is something to behold. Per our Backtest Engine, there were 192 days since 2000 when it was above 25%. Two months later, the S&P was higher 88% of the time. When the S&P was *below* its 200-day average, that rises to 90%.
Nearly half of the time the market bounces back above the 200-day moving average. Most of the gains come from averting complete disasters, which I expect to do by watching our recession and financial stress indicators.
Some readers have asked me for a catalyst. What could go right?
- We are now in the seasonally strong period for stocks. I do not see this as a major factor, but some do. It is a matter of psychology. (Barron’s). But the “reliably bearish” Randall W. Forsyth does not seem to recognize a positive seasonal period. Decide for yourself.
- Infrastructure spending. There is actually a good chance for this regardless of the election outcome. (Barron’s). It might happen as a GOP bill or with some Dem cooperation, but it is needed and attractive to both parties.
- And most importantly, firm progress on the Chinese trade issue. My current assessment is that this might generate a 4-5% move in a single day and 15% overall. If you own the right sort of stocks, your gains could be much larger. Some stocks are trading as virtual proxies on this issue, going through eight percent swings on a single day, even when the news is trivial.
The Fear and Greed Trader considers the facts and arrives at the right conclusion. I disagree about with his title theme, although it was a popular one this weekend.
Despite the warnings, this is not a crossroads for the market, but a choice for investors.
I’m more worried about:
- Frightened investors. Will those who have “all weather” portfolios stay the course? Will those who have been waiting for palpable fear start to buy? I fear for investors with no compass and the ripple effects on others.
- The gradual effect of the trade war. As I have often noted, it is a real-time econ lesson. The effects are more obvious each week – lower growth, higher inflation.
I’m less worried about:
- Earnings growth. It is a strong positive, even if not recognized right now.
- Election aftermath. The drag of campaign negativity will be gone.