Weighing the Week Ahead: Have Stock Prices Veered from the Fundamentals?
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The economic calendar has several of the most important reports. The managerial rosters will be back at full strength, perhaps after an extra day or two off. Investment committees will consider implications from Q1 results. Pundits will try to explain what it all means. They will ask:
Have stock prices diverged from the fundamental outlook?
Last Week Recap
In my last edition of WTWA I asked whether a trade war could be avoided. This was the key question for the week, and progress was more rapid than most (including me) expected. While not resolved, the stimulus to negotiation and delay in full implementation is encouraging.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. I always start my personal review of the week by looking at a great chart. I especially like the version updated each week by Jill Mislinski. She includes a lot of valuable information in a single visual. The full post has even more charts and analysis, so check it out.
The loss this week included a trading range of about 4%. This is in line with recent volatility, but not all in one direction, as was the case in several weeks during Q1. I summarize actual and implied volatility each week in the Indicator Snapshot.
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!
Feel free to add items that I have missed. Please keep in mind that we are looking for current news, especially from the last week or so. WTWA is not about long-term concerns like debt. These are important, of course, but not our weekly subject unless there has been some major change.
- Personal income just met expectations, but the gain of 0.4% is solid.
- Initial jobless claims declined to 215K, much better than expectations of 230K and a new cycle low. It is the lowest week since January of 1973. I like Bespoke’s chartbecause it shows both a longer-term trend as well as a focus on recent results.
- Q4 GDP revised higher to an annualized real rate of 2.9%, better than the last estimate of 2.5% and expectations for improvement.
- Pending home sales increased 3.1%, beating expectations and bouncing back from the January results (revised even lower). The index is still down 4.1% year-over year. (Calculated Risk)
- Bearish sentiment increased, a contrarian indicator. (Bespoke)
- Chicago PMI declined from 61.9 to 57.4, missing expectations for a slight increase. This is often an indication of the ISM index to be released on Monday.
Consumer confidence softened, although the market is not really treating the near-record levels as “bad.”
- Conference Board 127.7 with 130 prior and forecast.
- Michigan sentiment 101.4 with 102 preliminary and consensus. Despite missing expectations, this final reading is the highest since 2004 (Jill Mislinski).
- Home prices still lag historical growth patterns and measured in real terms, remain 11.1% below the bubble peak. Calculated Risk explains the importance of this approach instead of the typical comparison of nominal prices.
Managerial responses. I am struggling to find the right adjective for the delayed Facebook apology and policy changes. Large organizations are clumsy when there is no plan in place for a particular event. Facebook’s personal link to users contributed to setting the bar higher.
Michigan State University continues to struggle with the consequences of an institutional failure to protect its students. Just when it seemed like the Nassar story had played out, we learn of new charges against former MSU dean William Strampel. These relate not only to his supervision of Nassar, but allegations about his own acts of sexual harassment and assault. How is management handling the problem? Among other steps they shelled out over $500,000 to a consulting firm to monitor social media, including the accounts of victims.
Mrs. OldProf, when consulted on this question, rattled off some better ideas for a university to spend that amount, along with sympathy for the many innocent students and faculty with ties to the university.
We always hope that our institutions will improve on past mistakes, but this is not encouraging.
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 big economic calendar, featuring the employment report for March, the ISM manufacturing and service indexes (both), and auto sales.
There is a bit of FedSpeak. Congress is in recess. Despite this, the Washington circus may well dominate the news – once again.
Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.
Next Week’s Theme
The economic calendar is more important than usual, with key reports on employment, the ISM surveys, and data on auto sales. While there have been some soft spots, the economic story has remained strong and corporate earnings growth has been excellent. Meanwhile, stocks have given up the gains from early in 2018.
As fund managers, investment committees, investors – and of course the punditry – pause to review the quarter, they will see a mixed picture. Brian Gilmartin sets the table for this week. Earnings estimate revisions are strong, but Q1 stock performance was negative. What is the explanation?
Why the divergence between stock prices and the earnings outlook?
This question lies at the heart of investment plans. Here are the popular alternatives, beginning with those that question the fundamental strength to those that dismiss the current market “message.”
- At last! The market is finally starting to see the wisdom of my valuation measures. You can see AMZN plummet as people finally calculate its Q-ratio. And those pesky forward earnings increases will come down rapidly when this “half-cycle” is over and CAPE is king again.
- Early-year gains were built on false optimism. Reality has set in.
- The YTD results are quite normal if one looks at history. See the Jill Mislinski drawdown chart below.
- Welcome to normal! (David Templeton, HORAN)
- The Trump tax rally has met the Trump trade decline. This is the result. Mike Williams analyzes the distortions from mixing political viewpoints with investments. He observes how fear has become extreme despite slender evidence.
- Earnings prospects remain strong, despite challenges from the trade controversy. This remains true if one focuses on revenue, avoiding the typical arguments about measuring earnings. (Dr. Ed Yardeni)
- Markets eventually reflect reality – but perhaps not right away. (Eddy Elfenbein).
As usual, I’ll save my own conclusions for today’s Final Thought.
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 worsened this week. In mildly bearish conditions our trading approaches can still be profitable, but that might not be true for everyone. We continue to monitor the technical health measures on a daily basis. If this indicator goes to fullish bearish, we liquidate trading positions. This is not a forecast that the market will decline. It indicates increased difficulty in trading profitably.
The long-term fundamentals and outlook are little changed. The FOMC decision flattened the yield curve a bit, and that is one component of the C-Score. Based upon historical data for this indicator, I have increased the 9-month recession probability to the 18% range. I am monitoring, but not yet especially worried. Please see James Picerno below.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.
Doug Short: Regular updating of an array of indicators. Great charts and analysis. With more new reports, it is time for an update of the “Big Four” indicators. Results, while still solid, are a touch weaker in Q1 than at the end of the year.
James Picerno cites another Fed official, Loretta Mester, expressing skepticism about the value of the yield curve as a signal for economic weakness. Last week James noted a comment from the new Fed Chair, Jerome Powell, questioning the usefulness of yield-curve inversion as an indicator of the economy. That is something to watch!
Bespoke introduces an indicator based upon an aggregate of regional Fed surveys. I am not a fan of the individual components, so I like this idea. Just to provide a taste, he is a combination of the Capex element – especially important for continuing growth.
Insight for Traders
Our discussion of trading ideas has moved to the weekly Stock Exchange post. The coverage is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. Each week we explore a topic of current interest, drawing upon trading experts. This week we asked, “Do you keep a shopping list ready?” We discussed some stock ideas and updated the ratings lists for Felix and Oscar, this week featuring the S&P 500. Blue Harbinger has taken the lead role on this post, using information both from me and from the models. He is doing a great job, presenting a wealth of new ideas and information each week.
While my intent is to focus on traders, long-term investors may also benefit. That was especially true in this week’s post.
Insight for Investors
Investors should have a long-term horizon. They can often exploit trading volatility! I remind investors of this each week, but now is the time to pay attention.
Best of the Week
If I had to pick a single most important source for investors to read this week it would be Morgan Housel’s honest and insightful observation about the investment sales process, How to Talk to People About Money. Using powerful illustrative analogies, he explains how the process should be client-focused, not dependent upon the advisor’s own ideas. As he so often does, Morgan has put this well:
Claiming your investment product is entertaining is usually the refuge of those who can’t point to performance. But it’s crazy to assume that many people don’t find investing incredibly entertaining – so much so that they rationally do nutty stuff regardless of what it does to their returns.
Everyone giving investing advice – or even just sharing investing opinions – should keep top of mind how emotional money is and how different people are. If the appropriate path of cancer treatments isn’t universal, man, don’t pretend like your bond strategy is appropriate for everyone, even when it aligns with their time horizon and net worth.
The best way to talk to people about money is keeping the phrases, “What do you want to do?” or “Whatever works for you,” loaded and ready to fire. You can explain to other people the history of what works and what hasn’t while acknowledging their preference to sleep well at night over your definition of “winning.”
Colorado Wealth Management reviews some interesting dividend candidates for the rest of 2018.
Stone Fox Capital reviews Twitter (TWTR), including the effect of privacy concerns and Citron Research’s announced short position. The conclusion is that Twitter has much less to lose from tighter regulations.
Walgreens or CVS? Brian Gilmartin analyzes the history of the competition, developments in the business model, and of course, the relevant data.
Some REITs can withstand rising interest rates (Morningstar).
Brad Thomas has a REIT idea that includes a takeover kicker.
Making money from the mistakes of others? The less that is known, the better the chances. Julie Segal describes a fund based upon irrationality in the Chinese market.
The Mad Hedge Fund Trader asks whether it is “all over” for artificial intelligence after Uber’s Arizona accident. This is an interesting analysis of the worst-performing stocks of the last two weeks. I covered a similar theme in my post about market efficiency, using AI as an example. There are some good stock ideas in this sector.
Seeking Alpha Senior Editor Gil Weinreich continues his excellent about issues affecting financial advisors. It always has many themes of interest for individual investors. His How Fortunes are Kept post is well-suited for my own theme this week. I especially enjoyed Douglas Tengdin’s analyss of Uneven Growth. There are many heartbreaking examples of those who wound up seriously over-weighted in a single stock or two. Often, this is their employer. That doubles the danger.
Abnormal Returns has a special Wednesday focus for individual investors. There are a variety of ideas, and nearly always something you will find useful. I especially liked the Scientific American article, Why Is It So Hard to Talk about Money. I read many of the same sources as Tadas, but he regularly unearths something valuable that I have missed.
I especially recommend the section on communication with spouses. Mrs. OldProf, at year 8 or so of our marriage made an admission. She had been under the impression that college professors made a lot of money!
Strategy – Value Investing
Davidson (via Todd Sullivan) offers insights on when to expect the value strategy to work, and a couple of contrasting ideas. I especially like posts with an educational them and clear illustrations. These meet those tests.
Charlie Bilello (Pension Partners) explains that any investment factor, including the value approach, will have periods of significant under-performance. Most active managers are quick to dump something that has not “worked” for a year or two.
The problem? “…3-year underperformance is far from atypical for any smart beta strategy. To the contrary, large cap value has actually underperformed large caps in 51% of rolling 3-year periods going back to 1981.”
[Jeff] Strategies that work well in the long run usually have lagging periods. The drive for short-term performance leaves many active managers chasing what worked last year. Individual investors can choose better.
Watch out for
Pot stocks, according to a cover story in Barron’s. Bill Alpert analyzes the Canadian stocks, comparing valuations to other markets like gold and alcohol. He writes:
As they often do, investors have celebrated this emerging business early by embracing Canadian companies that claim a cannabis connection. Traveling in Canada, cabbies, bankers, and even border guards will tell you their favorites in a bubble that has floated Canadian cannabis stocks to a collective stock-market value above $30 billion. That’s already about half the market capitalization of Canada’s gold mining industry.
But a Canada weed glut is a real risk. At current valuations, marijuana stocks are already too high for an investor tempted to join the party.
Indexed annuities. Investment News reports that annual sales were the lowest since the late ’90s, apparently because of the fiduciary rule which went into effect in June. If you do not understand what this means, you should get a second opinion before buying an annuity.
Target date funds. Ronald Surz analyzes the gap between what beneficiaries seek and what the funds provide.
What is normal? Analyzing the market depends on what to expect. Intelligent people who follow financial news will see an “explanation” for everything, even when the market moves are below the typical noise level. No one on financial TV discusses signal to noise!
If your experience is limited to recent years, you will face some surprises! The market is returning to normal. It seems unusual only in the perspective of recent experience. Let’s take a closer look.
Market efficiency. Markets are efficient eventually, but often not in short time frames. I wrote a mid-week post to alert readers to the current action about how to exploit market inefficiencies. I hope you gained from the ideas, which worked well, but opportunity still abounds. Ben Carlson explains that returns are “lumpy.”
Risk. An important part of my interview with a potential client is aligning expectations with their personal needs and concerns. The multiple-choice tests for risk tolerance may be OK for satisfying regulators, but they do not really reveal much about the investor. An honest balance of needs and risk requires work. That starts with a realistic idea about risk.
Stock programs typically offer the highest potential return. We take several steps, documented regularly in WTWA, to limit the biggest risks. That said, 15-20% drawdowns go with the territory. There is usually not a clear-cut reason, although speculation abounds. After a period of extremely small drawdowns and hardly any volatility, even a partial return to normal can be upsetting. Volatility also seems greater because the moves reflect near-daily surprises out of Washington. The weekly update from Jill Mislinski provides perspective.
Volatility is normal. Despite the breathless TV commentary, daily stock average moves of 1% are normal. Your own holdings, if both attractive and aggressive, may have larger moves. Bespoke shows how volatility, as we have been documenting weekly, is gradually returning to normal levels. The point moves seem large with the averages close to all-time highs, but the percentage changes are routine.
Long-term investment prospects are solid. The three key elements are all in place:
- Expected earnings
- Low inflation expectations (and therefore bond yields)
- Low inflation risk
Since many confuse headlines with fundamental valuation measures, the market remains inefficient. There are many cheap stocks that are even more attractive than the averages. You just need to know how to look for them.
Early last year, there were many skeptical investors. When the tax cuts passed, many stocks celebrated the repatriation of assets and lower future rates. Investors who were out of the market often felt that they had missed a great opportunity. “If only…..” was a popular refrain.
What about a second chance, a reset? Since I stick to the numbers, I see a chance for investors to re-establish a basic stock position. You need not, and should not, go all in. You need a plan. Unless you expect to remain forever on the sideline.
Many investors wait for a dip and then are talked out of their plan it when it comes.
I’m more worried about:
- The investigation spiral. Is there a threat that the various allegations, lawsuits, and investigations will rise beyond the irritation level? I have no good answer, but my concern has increased in recent weeks.
- Leadership turnover. While it is not obvious to some, government agencies benefit from stable and experienced leadership. It is important to have loyal, honest, and dependable nominees at the head of agencies. They should also have an able and experience supporting staff. There is a recurring pattern of deviation from long-held and valuable historical norms.
I’m less worried about:
- Finding stock opportunities. Whatever your analysis of the Trump Administration policies, there is a winners list.
- Trade issues. There was, apparently and maybe, some progress this week. Certainly with S. Korea, and maybe on other fronts. There seems to be some progress in the Trump deal-making strategy.
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