Will the Fed Change Course?
We have yet another quiet week for economic reports, and it is in front of a holiday. Don’t worry. Pundits will find something to fill the empty time and space!
It is possible that we will have another week of political stories, but I expect a shift. Many will find it time to digest the recent economic data with a focus on the Fed. I expect many to be asking:
Will the Fed alter its policy path?
Last week the economic news was good, but the Wednesday decline dominated. As expected it was all about the political controversies.
In my last WTWA I predicted that accusations about President Trump would hijack the financial news coverage, including comparisons to Watergate. In my “final thought” (where I put my own opinions) I concluded that the controversy did not represent a downside risk, but there would be concern about the prospects for tax policy. This was one of my most accurate guesses about the week ahead. Those who read it properly – what a big news story really means for their investments – should have found it helpful during the Wednesday selling.
Those who looked only at the story’s (accurate) headline, or interpreted it as political commentary, or think that everyone should ignore potential threats to their pocketbook — these people will not be successful investors. For many, the comments seemed to offer an emotional outlet rather than an investment discussion. The Fear & Greed Trader’s weekly summary captured the essence of the investor problem – the political side show versus fundamentals.
I cannot help readers who would rather discuss politics than investing. As I explained in last week’s introduction, I do not choose the media focus for the week. I merely try to help in coping with it. Here is one of the best analyses – an expert source, reaching my conclusions, but after learning more information.
Let me ask this: Would you have been helped more by an investing site that did not even consider the biggest story of the week ahead?
The Story in One Chart
I always start my personal review of the week by looking at this great chart from Doug Short via Jill Mislinski. She notes the news-driven Wednesday decline, the recovery to a modest loss on the week, and the continuing near-record status.
Doug has a special knack for pulling together all the relevant information. His charts save more than a thousand words! Read the entire post for several more charts providing long-term perspective, including the size and frequency of drawdowns.
Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something very positive. My working definition of “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!
Once again, the economic news last week was good, but the market reaction was negative. Of course, there were other considerations.
- Industrial production was up 1%, beating expectations, and up 2.2% year-over-year. Steven Hansen (GEI) reports with a more nuanced viewpoint.
- Philly Fed’s Index registered a blowout 38.8. Steven Hansen (GEI) notes the trends and reminds us of the best methods for interpreting this volatile series.
- Revenue growth. Those complaining about the inaccuracy of earnings growth often turn to revenue. Brian Gilmartin has an important post showing information on this topic, by sector. Not only is growth increasing, so are expectations.
- Home Owner’s Equity is Rising. Marginal Revolution sees balance sheets in “good shape.”
- Leading indicators rose 0.3%, matching expectations, but reassuring to fans of this method.
- Homebuilder confidence continues the upward trend. Calculated Risk has the story, including this chart:
- Brazilian stocks and related ETFs (esp EWZ) plunged on new corruption reports. Ian Bezek has an interesting analysis.
- Building permits declined to 1229K from a prior annualized rate of 1270K. This was also a miss of expectations.
- The yield curve is flattening a bit notes New Deal Democrat in his analysis of high-frequency indicators.
- Housing starts decreased to an annual rate of 1.172 million. Calculated Risk notes that the change was mostly in multi-family, with single family starts up 7% YTD. Bill is maintaining his expectation that starts will increase 3-7% for the year.
North Korea is threatening to retire my “ugly” award. Complicating the problem is a general lack of knowledge on the part of Americans. A lack of information does not stop people from forming an opinion, of course. The Upshot reports that only 36% of Americans can find North Korea on a map. Those who can are more likely to favor diplomacy over military action. Take a try and then check today’s conclusion to compare your choice with that of others.
The Illinois budget situation and the need for public schools to increase borrowing is also pretty ugly.
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to David Bailey et.al. via CXO Advisory. One of the most pervasive traps for investors doing their own research is evaluating the record of forecasters and pundits. They often claim selective, cherry-picked credit. CXO Advisory for some years maintained a “guru grades” feature. The Bailey team has re-ranked the market forecasters after adjusting for specificity and time frame. In general, the scores are not very impressive, but your personal favorite might be an exception. Here is the summary:
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. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.
We have a very light week for economic data.
The “A” List
- New homes sales (T). Current strength continuing in April?
- Michigan sentiment (F). The final figure for May is expected to remain at a peak.
- Existing home sales (W). Not as important for first-order economic impact as new homes.
- Initial jobless claims (Th). Continues with record low levels.
The “B” List
- Durable goods (F). Volatile April data with weakness expected.
- Q1 GDP second estimate. (F). Not much change expected, and attention has already turned to Q2.
Crude inventories (W). Recently showing even more impact on oil prices. Rightly or wrongly, that spills over to stocks.
There is plenty of FedSpeak on the schedule. We also have President Trump’s travels and the continuing news flow about various controversies.
Next Week’s Theme
Once again, we have an economic news vacuum, and it is heading into a holiday. The A Teams will be eager to head for the beach. Almost anything could grab the news cycle, making it a risky guess for next week’s theme. I expect some reflection and digestion of recent economic data, with a focus on the Fed.
Pundits will enjoy a return to a favorite topic, asking:
Will the Fed Change Course?
As always, there are several viewpoints. Most observers seem to expect two more rate increases this year, beginning with next month.
- The Fed missed its chance to raise rates a few years ago, and now is hopelessly behind the curve.
- Economic data have been soft. A rate increase now is likely to create another recession.
- Economic data have improved. The so-called “soft data” is catching up with other reports. A change in Fed policy is a close call.
- The key for the Fed is whether to reduce the balance sheet or to raise rates.
- The economy is stronger than most think. Three rate increases are still in play – as is balance sheet reduction.
As usual, I’ll have more in my Final Thought.
We follow some regular featured sources and the best other quant news from the week.
Whether you are a trader or an investor, you need to understand risk. 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
The Featured Sources:
Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.
Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.
RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has several interesting approaches to asset allocation. Try out his new public Twitter Feed.
Georg Vrba: The Business Cycle Indicator and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. His interpretation suggests the probability creeping higher, but still after nine months.
Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.
Doug Short: The World Markets Weekend Update (and much more). His Big Four chart is the single best method to monitor the key indicators used by the National Bureau of Economic Research in recession dating.
How to Use WTWA (especially important for new readers)
In this series, I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have eight different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:
Are you preserving wealth, or like most of us, do you need to create more wealth?
Most of my readers are not clients. While I write as if I were speaking personally to one of them, my objective is to help everyone. I provide several free resources. Just write to info at newarc dot com for our current report package. We never share your email address with others, and send only what you seek. (Like you, we hate spam!)
Barry Ritholtz has a good post on the VIX and why it should not be viewed as a “fear index.”
The Federal Reserve Bank of St. Louis weighs in with its entry in the battling Fed forecasts for Q2 GDP. They are seeing 2.8%.
James Picerno warns against forecasting recessions based upon a single indicator. I hope that our regular readers were already on board with that concept, but the point is always new for some.
Best Advice for the Week Ahead
The right move often depends on your time horizon. Are you a trader or an investor?
Insight for Traders
We consider both our models and the top sources we follow.
Felix, Holmes, and Friends
We continue with a strongly bullish market forecast. Most of our models are fully invested. RoadRunner is fussy about entry criteria. The group meets weekly for a discussion they call the “Stock Exchange.” In each post I include a trading theme, ideas from each of our five technical experts, and some rebuttal from a fundamental analyst. This week our dip-buying Holmes model discusses why he is trading IBM. I joined in, describing the buy/write position in our yield program. RoadRunner plays upward trending channels and Restoration Hardware (RH). See the post for charts and more details.
Top Trading Advice
What is lost when trading on a screen instead of in a pit? Many of my friends are veterans of the pit. They describe the signals they got from their surroundings. Here is an interesting comment on the difference in trading from screens.
Volatility traders finally got the long-anticipated spike. Dana Lyons writes that trader fear (measured by the term structure of volatility contracts) also spiked. A 20% jump in this ratio has nearly always led to meaningful, short-term market gains.
Brett Steenbarger, returning from a well-deserved vacation has some extremely important advice about managing your expectations:
Our job is to trade with the odds and accept the probabilities that the odds may not play out on any particular occasion. Confidence in trading comes from the cultivation of a set of robust processes for identifying opportunity, expressing that opportunity as trades, and managing the risks associated with those trades.
Check out the full post for some helpful examples.
Insight for Investors
Investors have a longer time horizon. The best moves frequently involve taking advantage of 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 Chuck Carnevale’s important article, The Active Vs. Passive Performance Debate Is Nonsensical. The discussion on this topic has been so one-sided that many might be tempted to conclude, “case closed.” As he always does, Chuck mixes analysis with some excellent examples. He raises questions about what it means to be active, and how it is measured. But that is just the start. Here are a couple of the key points:
And even more to the point is the undeniable reality that there are numerous investing strategies and many of them are not designed to beat the market. Instead, and for example, there are strategies designed to produce income, there are strategies designed to mitigate risk and there are strategies designed to meet specific investor objectives – and many more. Therefore, I consider the raging debate of active versus passive investing nonsensical. Attempting to define the broad universe of investing strategies as either active or passive is simply too restrictive and/or general to be of any real value.
Furthermore, where is it written that as an investor I should have the singular goal of beating the overall stock market on a total return basis? What if I need more income than the S&P 500 index is capable of generating for me? Therefore, if I build a stock portfolio that produces significantly more dividend income than the S&P 500, have I somehow failed as an investor because my capital appreciation component may be lower? Personally, I think not.
Moreover, if I am judging my success or failure based on outperforming a benchmark such as the S&P 500 on a total return basis, this could prove problematic to my goals and objectives. The problem with total return investing is that I become subject to the vagaries of short-term price action. As an income investor, it is possible that I would be forced to harvest shares during a bad market in order to meet my income needs. Therefore, I would be invading my principal and doing it at a time when I might be better served to simply hold. But since I need current income, invading my principal is really not a viable option.
And much more.
Retail? Really? Anyone looking at this sector must never have heard of Amazon (AMZN)! Vito J. Racanelli takes a contrarian stance in this week’s Barron’s. I have listed the nine stocks selected as “survivors” but you should not jump in blindly. Take a careful look at the article and the reasoning.
Those interested in this idea should also read Marc Gerstein’s take on the topic. Providing a good lesson for those wanting to learn screening and backtest techniques, he begins with a hypothesis of what makes for a good retailer, selecting underlying characteristics for return on equity (ROE). Once again, you should read the analysis carefully before rushing to buy his survivors.
I found the contrast interesting, and I hope you will as well.
Peter F. Way’s analysis of Market Maker hedging suggests Goldman Sachs (GS) as “an odds-on buy for a near-term cap gain.”
Our Stock Exchange always has some fresh ideas. There are ideas from five different approaches. To my surprise, Felix (our long-term investor proxy) likes MercadoLibre (MELI).
Lee Jackson highlights JPMorgan’s favorite biotech stocks.
David Fish highlights the 18 increases among dividend champions before June 30.
Ploutos analyzes data on dividend vs. non-dividend stocks.
Eddy Elfenbein discusses a dividend champ that is making a 52-week low.
Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. If you are a serious investor managing your own account, this is a must-read. Even the more casual long-term investor should make time for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. As usual, investors will find value in several of them, but my favorite is about US Household debt, now back at 2008 levels. The overall debt level is a worry for many, but the L.A. Times explains that Americans’ finances are better.
Seeking Alpha Senior Editor Gil Weinreich has returned from his travels. He is back to providing advisors and investors alike with intriguing ideas and links. I particularly enjoyed his discussion of whether the lack of financial literacy meant that more personal finance education is necessary. If you believe the answer is obvious, read and consider his argument.
Watch out for…
Mall REITs. Brad Thomas sees a continuing “elevated risk.” He looks at the group through the lens of a single day’s trading. Then he turns to the exposure to specific retailers. It is an interesting approach that encourages you to look more deeply into how a given name is trading compared to the group.
The Fed story may well command attention. I classify it as an important story, but not an urgent one. I have some strongly-held viewpoints:
- The exact timing of rate hikes is not important for long-term investors. The Fed has been following a policy of rate increases in line with economic data. While many do not believe this, the data are supportive. Tim Duy on recent strength.
- That said, the rate increases have second- and third-order effects. The perception of the pace of hikes impacts exchange rates. The weaker dollar affects major corporate earnings – in both directions. This makes the Fed news worth watching.
- Current data are stronger than widely thought, but much depends upon how one views the Q1 softness—meaningful or aberrant. Recent Fed speeches suggest a moderation in the rate-hike path. (Merrill via Calculated Risk).
- Rates will be increased more slowly, but the balance sheet will be reduced.
As was the case last week, there could be a lot of noise next week – both from politics and from Fed speculation. If you have taken profits or are looking for trades, the week ahead might be one of opportunity.
And here is the map of people’s guesses about the location of North Korea, represented by blue dots.
© New Arc Investments