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Weighing the Week Ahead: A Defining Moment for Financial Markets

Summary:
The economic calendar includes several significant reports.  Housing data on new home starts, retail sales, industrial production, and leading indicators are all on tap.  Fed fans can ponder the Beige Book, anecdotal evidence from each district to provide color at the next FOMC meeting. Earnings season begins, and the Washington news will continue to dominate. It is another week when nearly all of the punditry will be asking the wrong question.  Astute investors should be asking: Does the trade negotiation process represent a defining moment for financial markets? In my last installment of WTWA, I took up a difficult and awkward topic – how the changing political landscape affects your investments.  The political developments were indeed a big topic for financial media,

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The economic calendar includes several significant reports.  Housing data on new home starts, retail sales, industrial production, and leading indicators are all on tap.  Fed fans can ponder the Beige Book, anecdotal evidence from each district to provide color at the next FOMC meeting.

Earnings season begins, and the Washington news will continue to dominate.

It is another week when nearly all of the punditry will be asking the wrong question.  Astute investors should be asking:

Does the trade negotiation process represent a defining moment for financial markets?

In my last installment of WTWA, I took up a difficult and awkward topic – how the changing political landscape affects your investments.  The political developments were indeed a big topic for financial media, but few provided a good link to investment effects.  It is difficult to divorce your own opinions of the candidates from the investment effect.

I also summarized my conclusions on the US/China trade talks.  That proved to be the big story for the week.

I always start my personal review of the week by looking at a great chart.  This week I am featuring Jill Mislinski’s version which combines a lot of useful information in a clear presentation.

Weighing the Week Ahead: A Defining Moment for Financial Markets

The market gained only 0.6% for the week but it was another wild ride. The trading range was 3.5%.  The big moves were all the result of breaking “news” in the US/China trade talks.  You can monitor volatility, implied volatility, and historical comparisons in the Indicator Snapshot below.

The Visual Capitalist has a timely feature on the economic history of the People’s Republic of China.

Weighing the Week Ahead: A Defining Moment for Financial Markets

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 calendar is an important one featuring housing data, retail sales, industrial production and leading indicators.  For those who can never get enough of the Fed, the Beige Book will be released on Wednesday.

As has been the recent case, Washington events will push the economic news to the back seat.

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

Weighing the Week Ahead: A Defining Moment for Financial Markets

Next Week’s Theme

I had expected to feature corporate earnings in this week’s installment.  Last week’s news has encouraged me to call an audible.  I cannot remember an occasion when so many market participants and pundits have been so wrong.  Their reasons differ, of course, but each approach leads to a poor conclusion.

This is a defining moment for investors.

It will take more than a week to play out, of course, but I expect nearly every aspect of the current market environment to change.  Those who understand the significance will enjoy a significant lead over the closed-minded and stubborn.

Background

The US/China trade negotiations generated negative news at the start of the week when there were rumors that the Chinese delegation would leave early.  The Presidential tweets over the next two days had only modest effect.  Thursday saw some serious rumors, including the overnight futures market.  Friday’s rally was supported by news that this would be an actual agreement.  The DJIA was up over 500 points at the high and sold off 200 points in the last fifteen minutes or so.

Let’s place this in the context of some of the key elements I have been expecting over the last eighteen months.  The summary I ran last week will serve our purpose here as well.

  1. An agreement would take a long time to achieve.
  2. It would not be comprehensive – too difficult and complicated.
  3. Progress would occur in stages, beginning with a partial truce and some general principles for further negotiation.
  4. An agreement would include face-saving provisions for both sides.
  5. The pressure to agree would be driven by the desire for a win-win solution.
  6. The Trump Administration would feel pressure from GOP leaders and donors, especially as the effects on their constituents became obvious.

Please observe that most of these points have not been mentioned in the Trump agenda.  He has consistently opposed partial deals and sought a “great” deal that would represent complete victory.  He has ignored or disbelieved the standard advice on the effect of trade wars.

The result has been a dramatic effect on global growth.  The US GDP impact exceeds 1%.  For Europe and China, it has been higher.  Emerging markets felt anything from ripples to tidal waves.  When this all started, I observed that many were about to get a real-time economics lesson.  It took longer than I expected for the message to get through.

Critics

We are about to see a week of criticism of the plan.  Here is part of what I wrote at FATrader, just before the late selloff.

“The much-awaited trade news is about to be released. I expect almost everyone to become a critic.

They will point out that the agreement is not comprehensive.

It will not be perfect.

The US will not get everything it wants.

In particular it will not “solve” the intellectual property problem.

As a citizen, you might care about all of these things and be willing to accept a recession to get them.  As an investor, your goal should be quite different.  It is enough for the self-inflicted pain to end.  And that is where we should set the bar.”

The biggest mistake by most will be setting the bar too high.  The discussion has drifted to the point where a “good” deal has China rolling over on intellectual property issues.  The US trade deficit with China will disappear.  It will be a comprehensive victory.

This was never going to happen without enduring a world-wide recession.  Even that might not have been enough.  Here are some criticisms you should expect with my reaction in italics.

  • The deal is not comprehensive.  And that is good!  It is much better to build mutual confidence by starting with the easier issues.
  • Nothing is in writing. Of course not!  So many expect the parties to meet for a few days and emerge with a detailed document.  These people have never written anything significant, and certainly have not worked as part of a writing team.  The projected time frames are reasonable.
  • Things will break down as negotiations move to the next stage.  And there will be at least one more stage after that. The chance of things breaking down is much lower than before.  The parties agreed on some provisions as well as categorizing the remaining issues.  This is much better than dealing with all at once.
  • The US is not emerging as the big winner.  Not according to the President.  I expect claims and symbolism on both sides to differ from the factual basis of a deal.
  • There will be stumbling blocks.  Of course.  And possibly delays.
  • This is just like the May agreement where the Chinese walked away from a deal that was 90% complete.  It is definitely not the same.  The May “agreement” was never announced by both parties.  The U.S. version was never supported by China. This time there is a joint announcement with plenty of reputation on the line.
  • How can there be such economic improvement when the market is already close to an all-time high. This is a big stumbling block for the average investor.  The market highs are relatively narrow and not based upon economic strength and earnings growth.  Many investors are not participating.  Fear has dominated, as the outflow from equities to bonds demonstrates.  Put another way, a stronger economy would support much higher stock prices – probably 10% on average and much more in the right sectors.

Investment Effects

It is easier to name the effects than to specify the time frame.  Let’s start with the former.

  • Economic growth will improve.
  • Long-term interest rates will move higher.
  • The yield curve will steepen.
  • The business cycle will be extended.
  • Interest-sensitive stocks and bond substitutes will be pressured.
  • Hard-hit industries will experience a rebound.

Some of these effects will be immediate.  Others will require the changing mood of a skeptical market.  The danger in waiting too long is that the psychology is that you have “missed the move.”  Chasing higher prices is a challenge.  That said, I expect this to play out over a period of months.

Interpreting Events

An interesting result of the defining moment is that most investment methods need a complete reset.  Here are some examples.

  • Bad earnings and outlook might not be so bad. Look for stocks where the trade effects are explicit, regardless of the current report.  Those have the most potential.
  • Forget the inverted yield curve and exaggerated recession odds.  Those who acted immediately at the first sign of an inversion need to plan a market re-entry.  This is why I always look for confirmation.
  • Poor current economic data are less important for our economic overview. That said, the “hard data” has remained pretty good.  It will now get better.
  • Threatening technical can be expected to improve.  (Our methods have shown the same warning as others).

I’ll have some additional observations in today’s Final Thought.

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.

Weighing the Week Ahead: A Defining Moment for Financial Markets

Short-term technicals continue to weaken and remain close to the highly bearish range.  Long-term technicals remain neutral and continue to weaken. Recession risk is still 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”.

Georg Vrba: Business cycle indicator and market timing tools.  The most recent update of Georg’s business cycle index does not signal recession.

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.  Great charts and analysis.

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.

I’ll focus more on specific investments next week in a return to the regular format.

I stated the theme of this post before the late Friday selloff.  Almost immediately there was evidentiary support.  Most of the articles focused on the late selling rather than the overall market strength.  Many attributed the rally to a change in Fed policy to stabilize the REPO market.  It became instantly popular to label this as a form of QE, the prism for many mistaken observers.

The main incentive for most is to appear smart.  This gets them better readings and ratings.  It looks good for clients.  The best way to appear smart is to explain what already happened!  Next best is to be a critic.

Suggesting that a policy change might actually improve things is usually dismissed as naïve cheerleading rather than informed analysis.  That is why the approach is so strong when you find a real edge!

I will share something that my team is working on, a final hint: Look at the stock performance on Thursday.  The winners then are the best general candidates for current investment.  The losers are the worst.

[This market inflection point has a big payoff if you get it right.  Follow my suggestions here, doing your homework, and you can join in. It might also be a great time for a little help.  Write for my free sector spotlight paper on housing, currently my favorite sector.  You will get some ideas about replacing over-valued stocks with those showing great potential. Just send an email request to info at inclineia dot com].

I’m more worried about:

  • Middle East tensions – now expanding.

I’m less worried about

  • The finances of the state of my residence.  It is looking at a big surplus.
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