Weighing the Week Ahead: A Time for Investors to Act

The News

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. The results are now positive in all time frames. NDD concludes:

Thus, barring new and worsening public policy moves, the weak manufacturing side of the economy is simply not going to be enough to overcome the solid consumer and drag the economy into recession.

The Good

• Pending home sales for September increased 1.5%, beating expectations of 0.7% and August’s (downwardly revised) 1.4%.
  
• ADP private employment for October showed a net gain of 125K jobs. This beat estimates of 95K, but September was revised lower, from 135K to 93K.
  

• GDP for Q319 (First Estimate) showed an annualized growth rate of 1.9%, beating estimates of 1.5% and close to Q2’s 2.0%. Dr. Robert Dieli issues a special report on the day of GDP releases. As usual, he provides detailed analysis, but also highlights the most important issues.
  

• The FOMC cut interest rates by 25bps and changed the language. The combination pleased markets. Leading Fed expert Tim Duy explains the message, a likely end to the “mid-cycle adjustment.” It will take more than a “status quo economic outlook” to justify another cut.
  
• Core PCE prices were unchanged in September lower than expectations for a gain of 0.1%. The Fed’s favorite price gauge leaves them plenty of room to act further should they decide it is necessary.
  
• Employment for October showed a net gain of 128K jobs, beating expectations of 80K. The prior two months were also revised higher by 95K jobs. The effect of the GM strike was about 40K, less than the 75K that many feared. Unemployment ticked up, but that mostly reflected an increase in labor force participation.
  

David Templeton (HORAN) concludes that there is little evidence for a near-term recession. He does a nice job of analyzing the changes in the labor force and the participation rate, including this chart.

The overall pace of net job gains has slowed to an average of 156K over the past six months from the three-year peak of 232K earlier this year. (James Picerno).

The Bad

• Consumer Confidence registered 125.9 in the October Conference Board version. This missed expectations of 127.5. September was revised upward from 125.1 to 126.3. Bespoke highlights the difference between current confidence and expectations.
  

• Chicago PMI was only 43.2, missing expectations of 48.2 and September’s 47.1.
  
• ISM Manufacturing for October registered 48.3, missing expectations of 48.7 but better than September’s 47.8. The market was untroubled by the close miss. As usual, many emphasized the slight contraction in manufacturing, a small and decreasing part of the economy. The ISM’s own research shows this reading as consistent with GDP growth of 1.6%, which seems about right. Trade war effects are frequently cited in the quoted responses.
  

The Ugly

California wildfires – and drones interfering with fire-fighting helicopters. Thankfully, the fires are now about 70% contained, but all of California is now in a state of emergency. Pre-emptive blackouts have created another life-threatening issue for other state residents.

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

The economic calendar is light, featuring the misunderstood JOLTs report and the ISM Non-Manufacturing Index.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

Last week featured an avalanche of data. If properly prepared, you were poised for analysis. Armed with this information it is time for synthesis. (See Brett Steenbarger in the “best of the week” section below). What did we learn that can help our investments? Put another way,

What actionable investments have become more attractive?

Background

Let’s begin with what we learned about the topics I highlighted last week.

• Employment. Results were a bit soft in the ADP report, but stronger than expected on Friday’s payroll employment headline plus revisions. It was a good report, but not a “blowout.” Friday’s rally seemed to show relief that the economic evidence was not recessionary.
• Other Economic Data. The market was mostly forgiving this week and on balance, the reports were good. The overall result is close to the 2% baseline I have been expecting – where we were before the tax cuts.
• Corporate Earnings. The beat rate remains good, although the size is a bit lower than the five-year average. (FactSet). Forward earnings expectations have been stable. (Brian Gilmartin) The earnings story is better than many feared but lacking a good catalyst. Trade issues and the strong dollar remain key headwinds.
• The Fed. Somewhat to my surprise, the market seemed to accept the apparent end to rate cuts.
• Trade Deal. There was an enterprising story suggesting Chinese skepticism about the ability to complete a long-term agreement with Trump. This generated the expected algorithm reaction and a decline of less than one percent.
• Impeachment. The market shrugged off news on this front, which certainly did not get more favorable for the President.
• Election. There was little reaction, even to stories about the cost of a “Medicare for All” plan.

Working Conclusions

The most important conclusion from this is that good news is once again good for equity investors. This is a sharp change from the story in most of the recent years – everything was parsed in accordance with the likely Fed reaction.

There is more confidence that a recession is not imminent. This has been a weight on expected earnings.

Most remain skeptical about a trade deal. Evidence of any problems caters to pre-conceived notions. Interviews with so-called China experts focus on how to succeed without a deal. If that is what readers believe, why not give it to them? (See this week’s Barron’s cover).

Investor and Media Reactions

The scary news still sells and is more common than ever. Here are a handful of examples I saw last week. Readers may wish to add some in the comments.

• Warren Buffett thinks the market will crash, which is why he has so much cash.
• There is a 1973 impeachment-era chart that looks much like we have today.
• Margin debt, worrisome when at the recent peak, is now a concern because it is moving lower. Don’t you just love indicators that give the same signal regardless of the reading?
• Things are so good, they have to get worse. This one is easy to create, since every decline starts with a peak. The problem? When there is a sequence of all-time highs, how do you know which will become the peak?
• With stocks at record highs, things must be dangerous.
• The stock market rally has gone on for so long that the end must be near.
• With all of the worldwide worries, referred to as “the fundamentals” by those slinging that pitch, something must be about to go wrong.

Wade Sloame captures the sense of investors who are “scared silly.” He examines the evidence of outflows from stocks and into bonds and invites readers to check out the opinions of friends.

The Real Fundamentals

The actual fundamental evidence can be measured and monitored.

Stocks are very cheap on a forward earnings basis when compared to bonds. (And this is how Mr. Buffett really does valuations). Value stocks are very cheap compared to the overpriced names at the top of the ETF list. Small cap stocks are cheap relative to large caps. Stocks beaten down by trade war effects over the past year are cheap relative to everything else.

Pursuing the inexpensive trades is not a play for 5 – 10% gains. Several of the factors imply valuation improvements of 20%. They can be combined and compounded, especially if you can dodge the over-valued names in the crowded trades.

This will not happen overnight of course. The real-time economics lesson of the trade war will take time to play out on the upside just as it did on the downside.

I’ll have some additional observations 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.

Long-term technicals continue to improve. Recession risk remains in the “watchful” area. We are seeing little confirmation for the risk signals, which we have been monitoring since May.

Considering all factors, my overall outlook for investors remains bullish.

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.

Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession, nor does his unemployment indicator. The latter shows a comfortable cushion before a signal.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

Guest Sources

Calculated Risk updates the analysis on the seasonal pattern for house prices. While seasonal data is better than the NSA version, it still shows the effect of the housing crash – an amplification of the seasonal wave.

Insight for Traders

Our weekly “Stock Exchange” series is written for traders. I try to separate this from the regular investor advice in WTWA. There is often something interesting for investors, but keep in mind that the trades described are certainly not suitable for everyone. The models have returned. We welcome my colleague Todd Hurlbut, Chief Investment Officer at Incline Investment Advisors, LLC. “Trending Todd” is of the technical persuasion, so he may side to much with our models in his analysis. I am keeping an eye on that!

This week we considered what it means to trade a market at new highs, a topic on the minds of many traders. As usual, we provided some trading ideas from the models along with expert analysis.

Insight for Investors

Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries 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 Brett Steenbarger’s How to Trade – 4: Going From Analysis to Synthesis. Ostensibly written for traders, Dr. Brett once again hits the bulls eye for investment analysis as well. He reviews the information from the first three posts in the series – all valuable. Here is what it means:

Gathering all this information and taking note of what it means is an essential part of market analysis. We generate trading ideas, however, by putting our analyses together into a coherent picture. It is that integration of data/analyses that I refer to as synthesis. It is the crucial creative element in trading. The creative, successful trader synthesizes information to generate perspectives that aren’t readily visible from charts and individual pieces of data. That ability to put the puzzle pieces together and see bigger pictures is an important element in what sets expert traders apart from the consensus herd.

[Jeff – And that is also the job of expert investors].

Brett then provides an excellent example of this method in action, using a specific trade. Here is how he summarizes it:

This is a very simple trade, typical of what I do. I look at multiple time frames and pieces of information and construct a view of the market based on trend and cycle behavior. Having analyzed the pieces of information and then synthesized a view, I structure a coherent risk/reward structure for my trade that tells me where I’m wrong (we drop below what I assumed was a cycle low) and tells me where we should go if I’m right (first target the point of control; later target the prior day’s highs.

This is exactly how traders should exploit inefficient markets.

Stock Ideas

Kirk Spano identifies a select group of companies that are poised for a rebound as oil supplies flatten. He suggests cash-secured puts as a good method for entering these trades. Check out the careful and specific suggestions.

Blue Harbinger joins in looking at the energy sector, highlighting the 13.6% yield for Vermilion Energy (VET). Do the company’s unique characteristics provide sufficient risk control? Mark also highlights Annaly Capital Management (NLY) as an mREIT with performance not dependent on low interest rates.

Water Utilities: 14% Trades From The ‘Oil Of The 21^st Century.
Double Dividend Stocks considers both the thesis and a micro cap stock.

Ploutos provides a helpful update of dividend aristocrat performance.

Gene-editing is getting closer to practical reality. Is Crispr the Next Antibiotic?

Peter F. Way applies his unique market-maker ranges to the world of biotech, identifying a possible big winner.

The Stanford Chemist screens for closed end funds that have a high yield, high coverage, and trade at a discount.

Brad Thomas still likes Tanger Outlets (SKT), even after October’s nice price rise. His analysis distinguishes it from other “mall REITs.”

Here is some good advice on When You Should Sell A Stock.

The Great Rotation

Bill Kort examines the assertion, ‘The Wrong Kind Of Stocks Are Leading The Stock Market To Records.’
He uses the recent statement from a chief equity strategist as the basis for a more careful look at current market prospects.

Investors are so fearful that today they are willing to accept a 1.82% return on a 10-year U.S. treasury note rather than a near 2% return on the S&P 500. I remind you that the S&P dividend was up 144% in the last 10 years. That T-note you bought 10 years ago yielded 3.43% (vs. 1.97% on The S&P) but the T-note yield did not grow, nor did its principal value.

Why should we love defensive leadership in the market?

We should love it because it signals fear and caution as the market moves into new all-time high territory. Fear and caution are never present at secular bull market tops.

Some small cap value ideas from Barron’s.

Is This Value’s Moment to Shine?

Personal Finance

Abnormal Returns is the go-to source for anyone serious about the investment business. The Wednesday edition has a special focus on personal finance, with plenty of ideas for the individual investor. As always there are many good links. I especially liked Warning! Frequently Checking Kid’s Grades Or Your Portfolio Is Bad For Your Health And Wealth. Readers will enjoy the charts, data, and examples.

Watch out for…

Betting on the come. Barron’s suggests that you might use options to replace your losing positions in stocks geared to a future development. Canopy Growth (CGC) is given as an example.

Final Thought

The key lesson from last week is that risk is lower than it seemed before. The major opportunities have also moved closer. Here are some specific suggestions for your consideration:

• Investors who have been frightened out of the market should edge their way back. You need not go “all in.” Your gut feelings are not a reliable method of market timing.
• Investors who are loaded up with expensive stocks and bonds should work to improve the balance.
• Investors who have some “catching up” to do have a rare chance. One quant expert has called it a generational opportunity. Try combining the themes I have described this week.

Some may wonder why I am so confident about this approach. Easy. The current times play nicely into my personal analytical strengths. I have spent a lifetime learning to identify the real experts. Like you, I am a consumer of expertise. Many of the best current opportunities require a combination of skills that is rare in the investment world. We have a nice mix of political science, public policy, economics, quantitative analysis, and market dynamics. These are my fields.

How am I handling this opportunity? For my clients I am developing a special program that will combine the key themes. Picking some ETFs is a good substitute for the DIY investor. I hope we’ll get discussion about some good ideas. My own program is building a portfolio of value (not deep value) stocks with definite relationships to the economics of the trade issues. I am combining three or four strong methods to identify a nexus of key stocks which we are beginning to purchase.

Since I am not expecting a market epiphany, there is not a rush. Take the time to do this right.

Analysis, Synthesis, and Carpe Diem

Some other items on my radar

I’m more worried about:

• Impeachment effects on a government shutdown. Some see this as a possible tactic.

I’m less worried about

• NAFTA 2.0 Some speculate that the impeachment issue is a stimulus for Democrats to play ball on this one.

© NewArc Investments, Inc.

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