We are back to a normal economic calendar, with Congress in session and plenty of FedSpeak. Until the government shutdown ends, I expect that to get maximum news coverage, followed by the President’s latest legal troubles. Since these are not the most important market stories, I want to examine more closely the debate about economic indicators rolling over. Some of the punditry will join me in wondering, How worried should we be about economic indicators declining from a peak? Some see this as a relatively normal decline from an overly exuberant pace of growth. Others see it as the first signal of imminent disaster. Let’s take a closer look. In my last edition of WTWA I asked readers to treat the new year as a blank slate. Rather than focus on recent events, I encouraged some
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We are back to a normal economic calendar, with Congress in session and plenty of FedSpeak. Until the government shutdown ends, I expect that to get maximum news coverage, followed by the President’s latest legal troubles. Since these are not the most important market stories, I want to examine more closely the debate about economic indicators rolling over. Some of the punditry will join me in wondering,
How worried should we be about economic indicators declining from a peak?
Some see this as a relatively normal decline from an overly exuberant pace of growth. Others see it as the first signal of imminent disaster. Let’s take a closer look.
In my last edition of WTWA I asked readers to treat the new year as a blank slate. Rather than focus on recent events, I encouraged some long-term thinking. Others added to my list, and it seemed to be a good exercise.
I also posted my annual preview for Seeking Alpha. This highlights the factors I see as most important in the year ahead. Currently it is only published on Seeking Alpha, so other readers should look for it there.
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. She includes a lot of relevant information in a single picture – worth more than a thousand words. Read the full post for more great charts and background analysis.
Stocks gained 1.85% on the shortened week, but it was a wild ride. The trading range 3.85%. While lower than last week’s range, it is still high – especially when it happens in two days. Our indicator snapshot (below) tracks actual and implied volatility over various time frames.
People get fixed in the moment, unable to see the future partly because they make the wrong inferences from the past. I am concerned about those who are obsessed with the rebound of specific stocks, which they see as crucial to market strength. In fact, the leadership is always changing. I’ll return to this theme in a future post, but for now, let’s look at Internet stocks. The Visual Capitalist has (yet another) great look at an important topic, The 20 Internet Giants that Rule the Web.
Notice the dramatic turnover!
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. This week’s update shows that the short-leaning indicators have joined the long-leading group in neutral. It will be interesting to see how this mixed picture plays out. NDD observes that some weakness first showed up in the long-leading indicators about seven months ago.
When relevant, I include expectations (E) and the prior reading (P).
- Rail transport improved in the “economically intuitive” sectors identified by Steven Hansen (GEI). He uses a rolling average to smooth this very noisy series. This chart illustrates his conclusion.
- The Fed responded to markets. Chairman Powell either blinked or walked it back or changed course, depending on the viewpoint of the observer. Some cheered a “victory” for markets over the Fed, expecting the Fed to accept the prevailing trader viewpoint of market weakness. They are delighted to see more data dependency. (Many of these voices are the same that criticized a data-dependent Fed in the Yellen era. They wanted to know a specific plan!) They are especially happy that the Fed promises to review the plans to reduce the balance sheet. My own conclusion is that the announcement was mostly cosmetic. The Fed looks at economic data, and traders believe that markets know all. The Fed was astonished that the small and gradual balance sheet reduction was viewed as alarming. This disconnect has existed for ten years, providing regular opportunities for the long-term investor. Whatever the reason, the markets loved the revised Powell message.
Employment news was excellent
- The ADP private payroll growth of 271K beat by a wide margin both the prior increase of 179K and expectations of 170K. ADP provides an interesting infographic and more detail.
- The employment situation report was excellent—improved payroll jobs, wages, and labor force participation. (WSJ)
…once again the flow of workers from out of the labor force directly into employment without even a month in which they say they are searching for a job continues to be an important feature. This, as has been the case since this recovery started in late 2009, means that the estimated labor force is not the real labor force, and since that is what goes in the denominator of the unemployment rate the estimated unemployment rate is not the measure of the labor market tightness that you should be using.
He also warns that this month is affected by difficult seasonal adjustments.
- The ADP private payroll growth of 271K beat by a wide margin both the prior increase of 179K and expectations of 170K. ADP provides an interesting infographic and more detail.
- Initial jobless claims increased to 231K from the prior week (and expectations) of 220K.
- ISM Manufacturing declined to 54.1 from a prior of 59.3 and expectations of 57.8. The ISM site provides plenty of useful detail. New orders declined from 62.1 to 51.1 and the comments reflected a general slowing pace. It is worth noting that the ISM’s own research concludes that a 54.1 reading, if annualized, would reflect real GDP growth of 3.4%.
- Apple issued a rare profit warning. This stimulated plenty of debate about the reasons: products, pricing, weaker economic growth, or tariffs. John Gruber has an interesting analysis which lays most of the blame on the company itself. (I heard other estimates that this is 80% an “Apple problem.”) The announcement had a dramatic impact on the overall stock market and a wide range of sectors – virtually anything that had any link to China.
- Q418 earnings estimates have declined sharply. John Butters (FactSet) compares the 3.8% current decline with past time periods. Hint: It is worse than the five-year average but better than the ten- or fifteen-year averages.
Government shutdown effects. You are seeing it on every news show. 800,000 workers not paid, although some are required to work. Important and popular services not provided. No guarantee of eventual reimbursement for some outside contractors. And no end in sight. Here is one summary with links to others. What if you owned a business catering to National Park tourists?
And mostly, why can’t we settle spending matters through the appropriations process instead of these ever more frequent threats to ignore contractual responsibilities and not pay bills?
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 is pretty normal, including several interesting reports. ISM services is expected to decline, but how much will it be? JOLTS is our best read on labor market structure. CPI is on trace to remain low. Despite all of the recent Fed discussion, I’m sure that some take a careful look at the FOMC minutes. Small business optimism is becoming more important as we wonder whether the negative news environment will chill business investment.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
I expect plenty of attention to the government shutdown and progress (or lack thereof) toward a solution. There will also be plenty of political posturing in the new Congress. Despite this, the employment news and market reaction will revive the debate about the strength of the economy. Many of the indicators show weaker readings. The favorite pejorative term seems to be that they are “rolling over.” This facile interpretation burns my bacon. Mrs. OldProf, noting my irritation, asked what I was writing about. “Rolling over,” I said. “Is it bad or can it be OK?” Looking back to an important football game she advised, “Rolling over can be good or bad. It depends on which direction.” She might not have meant the economy, but that was the only encouragement I needed. It is past time to ask:
How worried should we be about the decline of economic indicators from recent peaks?
Those with a worst-case viewpoint, see recession warnings everywhere. If you begin with a conclusion in mind, you can always find evidence. Dr. Brett Steenbarger writes:
We indeed see what we’re prepared to see, which is why we should prepare ourselves for a multiplicity of scenarios. Once we decide we *know* which scenario will unfold, we’re no longer prepared to see what could unfold. And that leads to losses and poor trading decisions. Feeling strongly about a view is as much a risk factor as a trading virtue.
Here is an example from Friday’s employment numbers. A famous economist, who has a place of honor on my twitter list for “reliably bearish” commentary, was reaching for something negative to tweet to his loyal following. This reach led him to an egregious blunder, using a result from the Household survey to “explain” job gains in the Payroll survey. Any real expert on employment knows that one counts people and the other counts jobs. The Household survey has a confidence interval of +/- 500K. No single month result can be used in the way he was. I gently suggested that and another problem in his analysis, with the typical twitter result: no response. This guy has a multimillion-dollar salary, earned by feeding confirmation bias. The erroneous analysis got hundreds of “retweets” of course.
The effect of the barrage is that the financial media start to take dubious findings as gospel. “This relates to the question of China weakening,” notes one CNBC anchor. “It is not a question any more. We all know it,” says the other. Where is the discussion about what it means for Chinese growth to go from 7% to 6% or 5.5%? The analysis consists of factoids, not data.
The U.S. weakening growth is moving into a normal range. Business cycle expert James Picerno posts, Moderately Slower Growth Rate for US GDP in Q4. His article includes changes in economic trends and a balanced discussion of the effect of current events. He includes estimates from a variety of sources. He begins with data, and then forms a conclusion.
Those really worried about “rolling over” should monitor the Big Four from Doug Short and Jill Mislinski. The most recent result is in today’s quant corner.
I’ll add my own method for testing these questions in 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 remain at the highest risk level. This reflects Vince’s research on the combination of factors that make successful trading difficult. It does not necessarily mean that markets will move lower, but the danger is there.
Long-term trading has also returned to the highest risk level. Those who emphasize technical analysis have emphasized the “damage” done to charts by the sustained correction. Our methods show that a clean bill of technical health will require some time.
Fundamental analysis remains strongly bullish. Earnings are great, prices are lower, and there is even less competition from bonds. We reduce fundamental positions (as we did in 2011) when we get a warning from the recession or financial stress indicators, not merely as a reaction to technical signals. At this point there are no significant fundamental warnings.
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.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession. Here is the latest update on his BCI indicator. And the most recent update of his unemployment indicator.
A recession starts when these indicators not only “roll over,” but also decline significantly from the peak. That is the official NBER dating process.
“Davidson” (via Todd Sullivan) notes that the end of a business cycle often includes a euphoric period. If the current cycle is like recent cases, the upside could be 4245 on the S&P 500. This is not a prediction, but analysis that could help investors see what is at stake. Too many see very limited upside.
Insight for Traders
Check out our weekly “Stock Exchange”. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we asked fellow traders how much cash they were maintaining and also cite advice from some expert traders. Currently, our models are mostly in cash. Wild and unpredictable swings create a dangerous environment. Our ringleader and editor, Blue Harbinger, provided fundamental counterpoint for the models, all of which are technically-based. The models have a much different approach to volatile markets than that which I recommend for long-term investors.
Insight for Investors
Investors should embrace volatility. They should join my delight in a well-documented list of worries. These are the best opportunities.
Best of the Week
If I had to recommend a single, must-read article for this week, it would be this commentary from “Davidson” (via Todd Sullivan), Markets Panic While Economics, Insiders and Valuation Indicate Buying Opportunity.
See the full post for more charts and data, but here is the key point:
Global markets are in panic, but economics, insiders, valuation measures indicate buying opportunity. To underscore the strong current economic trends, employment continues to rise and vehicle sales remain at decent levels. The recent pessimism is global and in my opinion is connected to price trends reinforced by the belief that it is simply ‘time for a market top’. The economic indicators do not agree with Household Survey Employment series which remains in a strong uptrend. This employment indicator has a history of rolling-over after vehicle sales have declined prior to prior market tops and recessions. There are no signs of such weakness in this data. Markets do not have specific timeframes over which they cycle. Markets are dependent on economic trends and respond after the fact. Market prices are driven by investors as they digest the information at hand. Most investors use price trends believing that someone else has better information than they do. Investors mostly act like a group of lemmings, nose-to-tail. A trend begins, they follow and continue to do so till economic data is sufficient to change the direction.
Eddy Elfenbein has announced his buy list for 2019! This much-awaited event is an inspiration for many investors, loaded with good ideas. Eddy is completely transparent in his holdings (which are locked in for a year) and provides frequent updates. Even better than reading the ideas, you can join me in owning shares of his ETF, CWS. He notes that this year’s picks include some dividend champions, a natural result of his selection process.
Blue Harbinger takes a careful look at the risks and recent decline before endorsing New Residential (NRZ).
Stone Fox Capital likes the 2019 prospects for 2018 leader, AMD. It is in a “market share gain phase.”
Barron’s suggests four low P/E stocks. I own one of them, AT&T (T) versus short calls, but I’ll take a look at the other ideas.
Barron’s also features Navistar, a cheap cyclical turnaround story with some takeover potential as a kicker.
Jeffrey Stafford (Morningstar) analyzes oil prices and recommends the volume-driven part of the sector. Check out the article for specific ideas.
Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Each week he highlights stories of interest for both advisors and investors. He also provides insightful commentary on important topics. Be prepared for something that cuts against the grain! This week he wrote about what investors might learn from the Apple decline and distinguishing signal from noise. He writes:
I will add one corollary that the falling Apple illustrated, namely that Apple did not succumb to old age or sickliness, but rather achieved losses greater than 496 of its S&P 500 colleagues at the very peak of its strength, after becoming first to attain 1 trillion-dollar market-cap status back in August.
Whether Apple recovers and the timing of that recovery are unknown. But Apple’s might and market prowess serve as an important reminder to investors not to place their faith in any specific companies but to spread their risks.
Abnormal Returns is an important daily source for all of us following investment news. I read it religiously. His Wednesday Personal Finance Post has some great New Year’s ideas for individual investors. Among the many good links (and the list of books) I especially liked Trent Hamm’s The 10 Most Valuable Lessons I Learned in 2018. Lesson #3 is about stress, but they are all practical suggestions.
Watch out for…
Utilities as a safe haven. Morningstar warns of a reprise of early 2018, but notes that risks are lower now.
Similarly, Mr. Buffett is switching $950 million dollars of floating rate notes to a thirty-year fixed rate. A signal about the bond market?
My expectation is (and has been) that the economy would revert to a rate of growth close to potential – something around 2.5%. Only a handful of Administration officials really believed that 4% was sustainable. A reversion to trend growth means that the economy – and many economic series – will grow more slowly. You can call this deceleration, slowing, rolling over, but don’t call it the start of a recession.
The astute investor trying to navigate the murky waters of economic data, should apply this test to recession claims:
Is this result consistent with 2.5% growth?
If so, ignore the surrounding rhetoric and turn the page.
Dr. Brett Steenbarger has a great post about how to navigate market turmoil and opportunity. He mentions some important sources, kindly including my thought piece from last week. The strength of Dr. Brett’s work is that it is data-driven. He goes where the data leads.
[If you are confused about the current market and unsure how to react, you might want to request some of my papers for individual investors. We can generate extra income from stodgy stocks. We also have identified investments that will profit the most in a reasonable economic environment. Just send an email to main at newarc dot com]
I’m more worried about:
- Compromise potential. The current shutdown is more about symbolism than substance. Usually these issues are resolved when one side sees it is being held accountable, but so far that is not working. The zeal of new liberal Democrats to initiate impeachment proceedings is another example of symbolism over substance. I still hope to see some progress, but it is a slow start.
- Government debt. Economic growth is solid, so it is time to be reducing debt. It is another real-time test of theory – the effect of the tax cuts.
I’m less worried about:
- Trade issues. The effects of tariffs are beginning to show. (See Timothy Taylor on steel). It is an economics lesson in real time.
- The Fed. This was mostly a communications problem, since I do not expect much policy change. Perceptions are important.