Good Questions but Poor Answers
The economic calendar includes several important releases, but few reflect the COVID19 effects. Everyone knows the economic news is dismal. Just how dismal does not seem to matter.
Investors want to know whether we have seen the bottom in stock prices. They ask, “When will people return to work?” Is it time to start buying stocks? If so, which ones? Serious market observers are discussing letters representing the future economic path: V, U, L, or W. (I wanted to create a memorable acronym from these letters and sought help from Mrs. OldProf. She admitted that some help from Vanna would be needed).
These are all good questions, attracting plenty of attention and many answers. The problem?
We are faced with many good questions but only poor answers.
Last Week Recap
In my last installment of WTWA, I attempted to demonstrate the need to understand the complex models diving key medical, economic, and government decisions. There was plenty of discussion on each of the key themes but little effort to show the relationships. The new issue of Barron’s had an article on each! It illustrates the need for a framework.
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 Jill Mislinski’s version, an excellent combination of the most important information.
The market gained 12.1% on the week. The trading range during the week was 9.5%, or 13.3% if we include the closing price from Friday, April 3, in the calculation. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.
For an interesting long-term look at daily trading ranges, here is another of the many great chart’s in Jill’s weekly update.
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 have always been a valuable part of my economic review. Eventually our focus will be on a turn in the economy. This source will be helpful for that purpose, as it was in identifying potential weaknesses going into the recession. The short leading and coincident indicators remain terrible. Long leading indicators continue to reflect the aggressive policy responses. Here is a key portion of NDD’s own conclusion:
The long-term forecast, buoyed by interest rates and Fed money supply intervention, remains just above neutral. As I said last week, public policy decisions made at the very top in Washington will determine the shape of the economic response to the pandemic, including whether short-term severe disruption becomes a credit and liquidity crisis, and whether a wage deflationary spiral (the subject of another post) begins to take root.
Until we have more relevant data, I will just hit the highlights and provide some interpretation. The pre-COVID19 reports continued to show strength. Job openings remained near the highs. Inflation data was low on the core readings (0.1% for CPI) and negative for the headlines. This was the result of low energy prices, making low gasoline prices another piece of good news for the few who are driving around!
Everything else plummeted, often missing even the lowered expectations. NFIB small business optimism dropped to 96.4 in March from February’s 104.5.
The decline inrail traffic is the largest since the Great Recession. (Steven Hansen, GEI).
Nearly a third of U.S. apartment renters did not pay rent in April (NYT).
Over one-quarter of the U.S. economy has gone idle. (WSJ).
Initial jobless claims hit 6.6 million, down from the prior week’s 6.9 million but worse than the expected 5 million. With the rapid shutdown of so much of the economy the spike in claims is not really a surprise. We simply have no background to evaluate the large numbers or how long the surge might last. Most of the layoffs are described as temporary and many are covered by increased unemployment insurance under the CARES Act.
Mortgage applications dropped 17.9% from the prior week and are now tracking the weakest years in recent history.
Michigan consumer sentiment dropped to 71.0. Jill Mislinski notes that this was the lowest reading since 2011 and the largest monthly decline in history.
The pandemic has inspired many acts of generosity, but it also brings out the worst in some.
People are luring Instacart shoppers with big tips — and then changing them to zero
[Jeff – seems like this could be fixed pretty easily, and it should be.]
Hospitals say feds are seizing masks and other coronavirus supplies without a word
[Jeff – One of many such stories I saw this week, as local administrators scramble for resources while seeing the peak needs approaching.]
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 economic calendar will include some important reports that cover at least part of the time after the spread of the COVID19 virus. We will see some effect in most reports and a full effect in mortgage applications, initial jobless claims, and leading indicators. I will keep running the calendar, but (as I have been emphasizing for weeks) we must remain conscious of the collection dates for data rather than the release dates.
As you can see from the expected results, the economists providing estimates are “going low.” So far, the guesses have not been low enough. Since everyone knows that a big chunk of the US economy is idle, the focus has turned to the likely length of the shutdown. (The Capital Spectator)
It is also the beginning of earnings season, normally a major topic for us. The conference calls will be especially important. Investors will look to company executives to provide some guesses about the impact of current events on their present and future business.
And of course, we will have many briefings, tweets, and political comments from all sides.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The economic calendar includes several important releases, but only a partial reflection of the COVID19 effects. Everyone knows the economic news is dismal. Just how dismal does not seem to matter.
Investors have quite a different list of questions:
- Have we seen the bottom in stock prices?
- When will we re-start the economy?
- Is it time to start buying stocks?
- If so, which ones?
- Will the future economic path resemble one of these letters: V, U, L, or W.
These are all good questions, attracting plenty of attention. Many answers are offered. The problem? None of the answers are any good!
We are faced with many good questions but only poor answers.
The current investor challenge is finding a few nuggets of valuable information. To do this requires some structure to our thinking.
Last week I described the importance of models for current investment decisions. The work is complicated and has serious limitations. That said, it has already provided important results.
- Policymakers have a better sense of how the virus is spreading and the steps required to slow that spread. Would any government have undertaken such dramatic steps without strong analysis of the flawed data?
- Medical personnel and leaders can better anticipate upcoming service demands.
- Estimates of economic impact justified policy responses that would have been unthinkable without strong evidence.
The framework I built remains important, but it does not lend itself to my WTWA posts. There are hundreds of articles and news items on each aspect of the problem. Many of them are good. In my semi-retirement quest to be as helpful as possible, I am combining two approaches.
- I will maintain the basic model structure and a long list of good sources in a separate area. (Please be patient with this work in progress. If I get too stressed, Mrs. OldProf will try to reduce my work hours!)
- In the WTWA posts I will highlight the most important developments I found that week.
Most of what I read always winds up on the cutting-room floor, but this process will make more information available to those who are interested in deeper study.
Remember the basic structure of models – Pandemic, Economy, Corporate Earnings, Stock Prices. There is no sound way to skip ahead in the chain. Each will get a link from the main page.
And finally, here is a friendlier description of the problem, Loose Lips: The Psychology of Rumor During Crisis. Here are some current examples.
With the spread of the virus came the rampant spread of rumors from many sources: news media, social media, neighbors, and websites. Some of these are harmless. Perhaps you read of dolphins swimming in the canals of Venice, taking up the space previously inhabited by boats. Some are wishful, like those indicating a vaccine will be available in the next few months or that gargling with salt water will stop the virus from entering the lungs. Others are divisive, like those stating that China deliberately manufactured the virus as a biological weapon. I am guessing you heard at least one of these rumors; none of them are true.
This is an interesting and readable article. I especially liked the WWII comparisons.
Taylor’s analysis appears to be drawn from work done by Allport, Knapp, and others in World War II. After analyzing 1,100 wartime rumors, Allport and Postman created the “basic rumor formula”: r = I × A, expressing the idea that rumor is a direct function of importance and ambiguity. When faced with highly important but highly ambiguous situations, rumor will be rampant.
The formula helps us understand why we embrace information that has no stated margin of error.
Let us now turn to the current update on the key model segments.
Scientific developments highlight apparent successes.
And the looming challenges.
Economic news includes the problem with small businesses.
Is it possible to put the economy “on hold” for a few months? Timothy Taylor explores both the attractiveness of the policy as well as some long-term consequences.
Policy choices center on when the economy might reopen and what privacy sacrifices might be required.
Antibody testing and retests? (Barron’s)
Yet people expect a sooner end. (Stat).
Stock Prices could make a big move.
Eddy Elfenbein on the “tentative news that social isolation policies are having an impact….Markets are celebrating, and it may be premature.”
Paul Schatz hedges his bets with 3 Scenarios for the Stock Market in Q2.
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.
For a description of these sources, check here.
Both long-term and short-term technical indicators continued at the worst reading and are not close to improvement. The C-Score improved slightly. It will now have a new purpose. It put us on recession warning last May, but the confirming coincident indicators never pushed us beyond the tossup level. Conditions are sufficiently clear that I expect an “official” recession call from the NBER that will set the starting date some time this year. It will not be March, since the March data do not really meet the dating criteria. It takes a large and prolonged decine across the economy. It is certainly going to be a large decline, but prolonged will be a matter of judgement. We also might escape the traditional two negative quarters, say some economists. For our purposes, none of this really matters. We will reset our thinking and let the C-Score work at helping us forecast the next cycle bottom.
I am treating forward earnings and the resulting measures as not meaningful until we get more clarity. The data in the table represent best guesses from the best sources.
I contine my rating of “Neutral” in the overall outlook for long-term investors since I would be neither a buyer nor a seller at this point.
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.
Doug Short and Jill Mislinski: Regular updating of an array of indicators.
Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index has signaled the recession, but the full indicator impact will not be seen until June.
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 pick a single article for investors to read this week, it would be my friend Rob Martorana’s How to Read Financial News: Coronavirus, Confirmation Bias, and Political Bias. He clearly explains the links between emotions and biases and our decisions. He stresses the current relevance, writing “Now more than ever we need to read the news with a clear eye about our emotions and biases…”
He provides an excellent framework, discussing each step in turn.
One problem in finding bias in stories is that people cling to their favorites and label opposing viewpoints to be “fake.” Rob draws upon Vanessa Otero’s work which includes this helpful chart. (Here is a larger, interactive version).
And finally, out of many other great points, he makes a personal observation that is confirmed by many current polls:
I read all types of news, from conservative to liberal, and everything in between. I have noticed that clients are reacting to coronavirus in a wide variety of ways, based on their worldviews and their political views. In general, I have found that politically conservative clients view coronavirus one way, and politically liberal clients view coronavirus another way.
Helping clients this way is an important part of providing sound investment advice.
Here are a few ideas to consider, but do not skip my recommended analytical process!
Chuck Carnevale discusses his current shopping list of quality stocks. Like many of us, he suspects more volatility ahead and hopes it will be a short time. He defines that as perhaps less than a year. Read the full post for his ideas and of course, watch the instructive video. He sees this as a time for preparation and research. I agree.
So, what is an investor to do? For me personally, I’m acting like Santa Claus -I’m making my list and checking it twice. My rational mind says that quality is supreme in this environment, and in that same regard cash is king. Therefore, I am actively conducting research on the highest quality companies that I can identify and find. Then I am building lists of high-quality stocks that fit various investment objectives. For example, I have put together a list of dividend growth stocks as well as a list of pure growth stocks that I believe will not only prevail during this crisis, but perhaps even prosper.
Too late to buy Zoom Video (ZM). Beth Kindig discusses the impressive post-IPO record of the company as well as the recent surge in price. She believes that it will still continue to outperform the market but is cautious about the current high valuation. Read the entire post for her nuanced conclusion. What makes the Zoom product more attractive than competitors? She writes as follows:
There are a few key product features that help Zoom Video stand apart from the competitors. These features may seem simple, but they are actually quite difficult to bake into a product.
“Viral mechanic” refers to the spread of growth across users as a built-in mechanism to the product. Zoom has a viral mechanic due to lowering friction.
Competitors such as Cisco’s (NASDAQ:CSCO) Webex, Microsoft Skype and LogMeIn (NASDAQ:LOGM) require bulky user accounts, downloaded applications and software, which restricts the one-to-many model. Technically, Google Hangouts also wants you to be logged into a Gmail account. This doesn’t work for enterprise teams on Microsoft Outlook. Corporate teams are also increasingly mobile, switch between devices, and need to join meetings very quickly.
Again, joining a video conference without downloading an application or software may seem minor, but it’s actually a driving force in adoption and virality. This micro improvement has an effect on the speed at which Zoom’s conference URLs are shared from one-to-many users.
Blue Harbinger suggests that some high-yield mREITs and bond CEFs have important support from the Fed. As a result, these are more attractive than other high-yield products. He explains the reasons, but it is wise to go gently and carefully with the high-yield products.
Colorado Wealth Management joins in with Rumors Of Mortgage REIT Demise Were Greatly Exaggerated.
The Great Rotation – Now the Great Reset
I have made it easier for readers to join my “Great Reset” project. I hope you will give it a try. There is no charge. We will not share your email. Most importantly, I hope we can learn from each other.
Ben Carlson describes the decline of small cap value stocks and the weaker rebounds. He next looks ahead to performance in the wake of a bear market, cautioning that each case is different.
Some analysts are already discussing how the Great Reset may help to start the Great Rotation. Scott Welch, Chief Investment Officer – Model Portfolios at Wisdom Tree, begins by mentioning the market valuations of small- and mid-cap stocks. How this plays out depends on the business cycle. Here is an example.
The full article has additional ideas of what the shift in the business cycle might bring.
We understand how difficult the current market conditions are, and how difficult it can be to look past the volatility, stress and anxiety, and take a longer-term perspective on portfolio allocation. But, as we have suggested before, we do believe this will end, and the market will recover. We don’t know when, and we accept that we may have further down to go. But the current crisis will end, and the market will recover.
In anticipation of that time, we believe now is an excellent opportunity to think about and plan how to lean back into the markets. History suggests that there are certain investment styles, strategies and risk factors that will lead the way once the recovery begins.
Watch out for
Shale oil stocks. Kirk Spano takes note of the bankruptcy potential in these companies. His conclusion: “Sell your shale oil stocks now.” Read his entire post for the financial analysis and a few possible exceptions.
United Airlines (UAL). D.M. Martins Research continues the analysis on this sector concluding that there are “better options” than UAL.
Why the big market rally? It is mostly a result of the overwhelming response of government – much more than anyone expected. Except me. I have been writing about this for weeks. I am better at forecasting what is likely to happen than how the markets will react. By now I should realize that factoring in policy changes is a continuing error of nearly everyone in the investment community – intense skepticism about government powers and willingness to act. It puts so many on the wrong side of the market and then biases their future analyses. I hope readers have found my comments helpful in keeping a balanced viewpoint and portfolio.
As we move down the chain of models, the conclusions from our sources become more contradictory. They often look like guesswork. You can find a billionaire investor or pundit on either side of the stock rebound question, especially given the loyalty to the “must retest the low” concept.
The economic effects are somewhat more conditional. Analysts realize that it depends on when a semblance of normality returns. There is still a very wide error band on these estimates. The results depend upon the willingness to take the risk of another virus round if measures are relaxed too soon. There is a vigorous debate about the implied morality of these decisions.
Try to check out credentials. Ignore economists speculating about what policies will become reality. Ignore politicians discussing the implications of scientific data. Ignore “global managing partner senior chief investment officers” who are discussing any of the above. Ignore sources that are “famous for being famous” without any real credentials. Ignore anyone guessing what the market will do.
With the remaining sources, follow Rob Martorana’s guide to reading investment news.
This is a special time and requires special care. Here are my conclusions and what I am doing.
What Will Not Work
- Did you think you had an “all weather” portfolio? You probably missed a chance to lighten up as recession odds increased. This will limit your chances to take advantage of the eventual rebound. Rebalancing your allocation will help, especially if you target purchases with the right stocks.
- ETFs. Many stocks will not survive. Do you want to own them? An ETF combines the bad with the good.
- Market timing the bottom. Someone will guess right of course, but we don’t know who it will be.
What Will Work
- Individual stock selection following a strict process.
- Will the company survive? Verify the balance sheet, cash flow, and the Altman Z score.
- Use an earnings model like FAST Graphs. Check the valuation sensitivity of a near-term earnings hit.
- Use a revenue model like Prof. Damodaran’s to check out discounted FCF. This will provide another sensitivity test using different inputs and assumptions.
- Selling volatility via covered calls or cash-secured puts.
This means doing your homework on each stock. It takes time but avoids costly mistakes and finds the best opportunities. If you are sheltering in place you have time to do some extra study of stock valuation!
[This is the time when I (with the help of my team) can provide the most help. The stakes are high for both risks and rewards. Request a consultation via info at inclineia dot com].
I’m more worried about
- Rumors, misinformation, and disinformation. Just when accurate information is most needed, some are more interested in inflaming fears or selling false hope.
- North Korea. It feels too quiet.
- Excessive public optimism about a return to work, pressuring policymakers into an unwise decision.
I’m less worried about
- A great depression. There are signs of real progress. It will be a gradual return to work, and I will probably be in the last queue!