(By Jeffrey A. Miller) We have a very interesting week ahead. Despite the gravity of the issues, not much will be happening. Congress, after convening for a few days, will be back on vacation recess. There is not much news coming on the economic front. Equity markets will be closed on Thursday and open only for the morning on Friday.
In many shops, the "A" team will be off all week, so initiating new positions will be limited.
Alert: The prices and trades still count. If you can find a bargain, you get it.
The non-stop fiscal cliff coverage remains intense. There is a lot of buzz right now about "protecting your portfolio." This is amazing, since the underlying framework of these issues has been known for at least 1 1/2 years, and widely publicized (at this site and elsewhere) for months. By definition, anyone who is only now getting interested does not understand the fundamental issues.
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For the average investor there is danger in these messages. Successful traders (like our Felix model) make relatively fast moves, responding to trends and rule-based systems. Unsuccessful traders learn that their system was flawed. None of the systems considers market fundamentals directly, expecting instead that anything relevant is part of the message of the market.
Successful investors do the opposite. They determine the value of a business and then see if they can invest at an attractive price. Think of it this way. Everyone ridicules the "greater fool" theory -- buying an overvalued stock because you hope someone else will soon pay an even higher price for it. Selling an undervalued stock is no different. You are no longer investing, but instead guessing that the market will allow you a better future price.
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No one explains this better than Warren Buffett, commenting on the "portfolio insurance" method of deciding when to sell:
If you've thought that investment advisors were hired to
invest, you may be bewildered by this technique. After buying a
farm, would a rational owner next order his real estate agent to
start selling off pieces of it whenever a neighboring property
was sold at a lower price? Or would you sell your house to
whatever bidder was available at 9:31 on some morning merely
because at 9:30 a similar house sold for less than it would have
brought on the previous day?
Moves like that, however, are what portfolio insurance tells
a pension fund or university to make when it owns a portion of
enterprises such as Ford or General Electric. The less these
companies are being valued at, says this approach, the more
vigorously they should be sold. As a "logical" corollary, the
approach commands the institutions to repurchase these companies
- I'm not making this up - once their prices have rebounded
significantly. Considering that huge sums are controlled by
managers following such Alice-in-Wonderland practices, is it any
surprise that markets sometimes behave in aberrational fashion?
Many commentators, however, have drawn an incorrect
conclusion upon observing recent events: They are fond of saying
that the small investor has no chance in a market now dominated
by the erratic behavior of the big boys. This conclusion is dead
wrong: Such markets are ideal for any investor - small or large -
so long as he sticks to his investment knitting. Volatility
caused by money managers who speculate irrationally with huge
sums will offer the true investor more chances to make
intelligent investment moves. He can be hurt by such volatility
only if he is forced, by either financial or psychological
pressures, to sell at untoward times.
One of the biggest problems for investors who try to make big market timing decisions is constantly monitoring events. Take a look (via Doug Short's great chart) at what happened in Friday's trading:
And this is just the beginning, induced by a single phrase. Scott Grannis, despite his disappointment with the election outcome, is able to look objectively at the economy and the markets. He concludes that "lots of bad news is priced in" and provides the charts to show it.
There are many different methods for success in the investment world. Successful traders may be selling based upon their technical signals. Successful investors may be buying based upon fundamentals.
I'll offer my own take on protecting your portfolio and also what I expect from Washington in the conclusion. Let us first do our regular review of last week's
news and data.
Background on "Weighing the Week Ahead"
are many good lists of upcoming events. One source I
especially like is the weekly post from the WSJ's Market Beat blog.
There is a nice combination of data, speeches, and earnings reports. This week you can see video if you prefer.
contrast, I highlight a smaller group of events. My theme is an
expert guess about what we will be watching on TV and reading in
the mainstream media. It is a focus on what I think is important
for my trading and client portfolios.
This is unlike my
other articles at "A Dash" where I develop a focused, logical
argument with supporting data on a single theme. Here I am simply
sharing my conclusions. Sometimes these are topics that I have
already written about, and others are on my agenda. I am putting
the news in context.
Readers often disagree with my
conclusions. Do not be bashful. Join in and comment about what we
should expect in the days ahead. This weekly piece emphasizes my
opinions about what is really important and how to put the news in
context. I have had great success with my approach, but feel free
to disagree. That is what makes a market!
Last Week's Data
Each week I break down events into good and bad. Often there is
"ugly" and on rare occasion something really good.
My working definition of "good" has two
- The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
- It is better than expectations.
The economic news last week was mostly negative, especially because of Sandy.
- Inflation remains tame. Calculated Risk has a great chart showing various inflation measures. The key takeaway is the PCE measure. This is preferred by the Fed since it avoids some of the CPI issues related to housing and imputed rent. It shows that there is plenty of room for more Fed stimulus.
- Job growth is better than we thought. Also, the pace of job creation is excellent, about 6.9 milllion jobs for the quarter. The BLS provides quarterly data that shows the actual job count from state unemployment data. This is important, since it represents hard data from companies that are not lying about their insurance premiums. No one pays any attention, since we do not know these results for about eight months after the fact. We now know that job growth from December to March was 814,000 jobs. This is really good -- about 140K per month better than we thought at the time. It also means that those disparaging the monthly improvement by making snarky and knowing comments about birth/death models and seasonal adjustments were wrong. Don't hold your breath waiting for a correction.
The economic data last week was pretty soft, but it will be a challenge to disentangle the Sandy effects. These reports represented a clear break from better-than-expected economic data over the last few weeks.
- Retail Sales were down 0.3%. This is one of several data series showing the effects of Sandy.
- Initial jobless claims spiked to 439K, well above recent levels. This is another Sandy spike which may continue for another week or two.
- The FOMC minutes seemed to create uncertainty about future intentions. I am scoring it as "bad" because that was the market reaction, accurately described by Steven Russolillo. A better clue came from Fed Vice-Chair Janet Yellen, head of the communications committee. Joe Weisenthal covers her explanation of the Fed's open-ended policy, which is actually more aggressive than in the past. The QE3 approach is supposed to have an impact on market expectations, but so far it is not working.
- Industrial production rolled over with a disappointing decline of 0.4%. Calculated Risk expects a bounce from this Sandy-influenced data point, but the current weakness is evident from the chart:
The Gaza Strip conflict -- no winners, pain and loss of life, greater risks for everyone, and no clear solutions. The Indicator Snapshot
It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:
The SLFSI reports with a one-week lag. This means that the
reported values do not include
last week's market action. The SLFSI
has moved a lot lower, and is now out of the
trigger range of my pre-determined
risk alarm. This is an excellent tool for
managing risk objectively, and it has
suggested the need for more caution. Before
implementing this indicator our team did
extensive research, discovering a "warning
range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.
The SLFSI is not a market-timing tool,
since it does not attempt to predict how people will interpret
events. It uses data, mostly from credit markets, to reach an
objective risk assessment. The biggest profits come from
going all-in when risk is high on this indicator, but so do
the biggest losses.
The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread."
Bob and I recently did some videos explaining the recession
history. I am working on a post that will show how to use this method.
Bob and I met last week, planning an update soon after the election.
As I have written for many months, there is no imminent recession
concern. I recently showed the significance of by explaining the relationship to the business cycle.
RecessionAlert uses a variety of different methods, including the ECRI, in developing a Super Index. They also offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. Dwaine Van Vuuren notes that the effects of Sandy have pushed industrial production into recession territory, sending the current chance of a recession over 11% according to one of his indicators.
Doug Short has excellent continuing coverage
of the ECRI recession prediction, now over a year old. Doug updates
all of the official indicators used by the NBER and also has a helpful
list of articles about recession forecasting. Doug's latest commentary includes the following:
"As the average of the Big Four charted above illustrates, growth in
recent months has essentially flat-lined, and we still face the
near-term impact of Sandy on the economy and the longer-term impact of
how congress ultimately deals with the various components of the Fiscal
Cliff. At this point in time, I think it is quite possible that the NBER
could eventually date a new recession from some point in the third or
fourth quarter of 2012. But I remain of the view that ECRI's 2011
recession call was painfully premature. Note that in the second bulleted
interview link above, Achuthan asserts on WSJ Live that the NBER would
eventually put the recession start in Q3 or Q4 ... of 2011."
For the current time period to be viewed as the start of a recession, we would need to have a significant decline in the economy. Then the NBER goes back and dates the start of the recession at the last peak. We shall see.
Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong. Newly added to the list of errors this week was the popular but bogus 100% recession chart.
Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll.
We have a long public record for these
positions. This week we continued our bearish position.
These are one-month forecasts for the poll,
but Felix has a
three-week horizon. Felix's ratings have continued to drift lower.
The penalty box percentage measures our confidence in the forecast.
That measure has moved to the very top of the range. This means that
there is so much conflict in the indicators that we do not have a lot of
confidence in the current bearish rating. It has been a close call
the last few weeks, but a winner so far.
(For more on the penalty box see this article.
For more on the system
ratings, you can write to etf at newarc
dot com for our free report package or to
be added to the (free) weekly ETF
email list. You can also write
personally to me with questions or
comments, and I'll do my best to answer.)
The Week Ahead
This week brings more economic data, but not the most important reports.
The "A List" includes the following:
- Initial jobless claims (W). One day early this week. Employment will continue as the focal
point in evaluating the economy, and this is the most responsive
indicator. The Sandy effects are obvious and still expected this week.
- Building permits (T). The best leading indicator on housing.
The "B" List" includes these entries:
- Existing home sales (M).
- Housing starts (T).
- Leading economic indicators (W). Probable Sandy effects.
There will be continuing non-stop speculation, attempting to parse the words of anyone who will discuss the fiscal cliff.
Trading Time Frame
Felix has moved to a more bearish posture. It has
been a close call for several weeks. Felix
has done very well this year, becoming
more aggressive in a timely fashion, near the start of the
summer rally. Since we only require three buyable sectors, the
trading accounts look for the "bull market somewhere" even when the
overall picture is neutral. The ratings have moved lower again this
week. We are now 100% short in trading accounts via three inverse ETFs.
Investor Time Frame
Each week I think about the market from the perspective of different
participants. The right move often depends upon your time frame and
risk tolerance. Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."
This usually leads to mistakes in market timing. Here is what to think about:
- Risk. If you are like the average
investor you have it all wrong. You have been piling into bonds, gold,
and dividend funds. All of these categories are now over-valued, the
result of this stampede.
- A portfolio anchor. You need stability.
If you are trying to do it with bond funds, you need to understand the
risks. I prefer owning specific bonds.
- Stretching yield. My approach is to find
some reasonable dividend stocks and sell near-term calls against the
positions. If you did this skillfully, you could hit double-digit
annual returns with significantly less risk than simply owning dividend
- A little octane. Many investors do not
think carefully about asset allocation. There is always volatility, so
the key is to "right-size" your position. Instead of trying to time the
market, try to be a player in the right sectors, the right stocks, and
the right size. There are plenty of stocks selling cheaply in terms of their historic P/E multiples.
We have collected some of our recent recommendations in a new investor resource page
-- a starting point for the long-term investor. (Comments and
suggestions welcome. I am trying to be helpful and I love feedback. We
have a good discussion going on bonds versus funds, and I plan a
separate article that will provide a further forum.)
Final Thoughts on Opportunity, Risk and Methods
The best way to protect your portfolio is to create the right asset allocation, understanding that there is always volatility. If you are troubled by corrections in normal ranges -- the sort we have every year -- then you have not "right-sized" your position.
We now have more clarity on the fiscal cliff issues Here is what I see:
- A resolution to tax issues that will cover at least the entire calendar year of 2013. This will include the Alternative Minimum Tax, the "doc fix" for Medicare adjustments, and the extension of Bush-era tax cuts.
- Despite the more extreme comments, everything is on the table. The revenue package will include more from the very rich, but the dividing lines and rates could be something you have not even heard yet. I expect captial gains and dividend taxes to peak at 20-25%
- Some of the longer-term changes in spending and entitlements may get very hard targets right now, with the opportunity for the new Congress to fill in the details.
- This could all happen very quickly. It is NOT like last year. There are specific consequences for individual taxpayers, not just a general principle like the debt ceiling or a recession. Congress also wants to adjourn before Christmas.
My conclusions are based on watching and reading dozens of reports. There has been plenty of action behind the scenes. The incentives have changed for all of the participants. Those who do not see the difference just don't know what to watch for.