Weighing the Week Ahead: Fundamentals Versus Fear

Each week there is some new reason to be afraid.  None has had legs, but that does not seem to be relevant.  

Many seem to be repeatedly fooled by small riffs on the same theme.

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For investors, the focus should be on expected corporate earnings.  Instead, so many try to be armchair global analysts, evaluating the latest piece of news from somewhere in the world.  There are two flaws in this approach:

  1. There are always many problems — hundreds of countries and thousands of issues.  It is never perfect.
  2. The proposed solutions take time to play out.  There is never universal acclaim, even for good plans.

The result?  If you are waiting for an era of no problems and perfect solutions, you are not an investor.  You are an observer, or critic, or political commentator, but you are not going to find winning investments.

When economic fundamentals are improving, as they are now, it is time to pay attention.  Let us see this by checking out the data.

Background on “Weighing the Week Ahead”

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important in the coming week.  If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

In most of my articles I build a careful case for each point.  My purpose here is different.  This weekly piece emphasizes my opinions about what is really important and how to put the news in context.

Last Week’s Data

The important US data from last week was very encouraging, but the market did not really respond.  Let’s take a closer look.

The Good

Economic news continues to beat expectations.

  • Initial jobless claims have made another nice move lower, to slightly over 400K.  The four-week moving average is at the lowest level since the pre-Lehman failure days of August, 2008. Improving employment requires reducing job losses and improving job creation, so I watch both very carefully.
  • The ECRI weekly leading index is at a 26-week high.  The growth index is still slightly negative, but at the best levels since mid-May.  The ECRI said three weeks ago that a near-term recession was off of the table.  Each week we have more evidence that they are correct.  It is also apparent that those who made dubious interpretations of the ECRI indicator were wrong.  I tried to demonstrate their error back when readers could still profit from the knowledge.
  • University of Michigan consumer sentiment made a large and unexpected positive move.  [Readers should note that this is an excellent national survey, not a poll of my fellow Michigan fans who are in the dumps after (yet another) loss to (The) Ohio State University.  My deal with my OSU PhD and faculty brother is that the winner gets to call and gloat for a bit, and the calls are getting tiresome!]   This is really good news, since it reflects on job creation as well as other elements of well being.

 The Bad

There was also some discouraging news.

  • Shadow inventory of housing rose again, according to CoreLogic, with more foreclosures in the pipeline.  This is an estimate of how much new supply there might be, based upon delinquent loans in the pipeline.  There are many questions related to this analysis, but the increase of more than 10% since August is surely negative news.  Any improvement in housing requires an increase in the sales pace, and we are not yet seeing that.
  • The Fed cut growth estimates for this year and next by 0.5 to 1.0%.  The Fed has actually been better than private forecasters, so changes in the growth estimates are important for those of us who focus on data.  The Fed estimate for 2011 is now 3.0 – 3.6%.

The Ugly

Stocks sold off sharply on news that North Korea fired some rounds at a South Korean island, and that Ireland was going to need a bailout.  The exact causal relationship is interesting.  News like this sends the dollar higher in a “flight to quality.”  The most important ongoing market factor in recent months has been the inverse relationship between stocks and the dollar.

Did stocks decline because of Korea?  Because of Ireland?  Or was it because of the dollar?

For the average investor, it does not really matter.  Fear reigns.  Bad news anywhere in the world gets maximum play — quite logically, because it is news.  Analyzing data is boring, even if it is more profitable.

 Our Own Forecast

We base our “official” weekly posture on ratings from our TCA-ETF “Felix” model.  Felix caught most of the recent rally, and we are shifting to neutral this week.  The number of sectors in the penalty box, a sign of near-term risk, has increased dramatically.  While there are still a few sectors to buy, we are shifting our multi-week bullish posture to neutral in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

  • 43% of our 55 ETF’s have a positive rating, down from 64% last week.
  • 93% of our 55 sectors are in our “penalty box,” up sharply from 71% last week.
  • Our universe has a median strength of only -7, down from +5 last week.

The picture continues to be significantly more cautious than it was a few weeks ago.  For trading accounts, we had only 60% exposure during the past week, but we increased the allocation on Friday.

[For more on the penalty box see this article.  For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly email list.  You can also write personally to me with questions or comments, and I’ll do my best to answer.]

The Week Ahead

Any week including the employment situation report can be important.  Despite the large margin of error and the large revisions, the market focuses on this report.  Employment is so important that people look beyond the shortcomings of the data.

Because of the improvement in sentiment and jobless claims, I expect a better employment report.  The final piece of data that I use is the ISM index, which we will also see this week.

In addition to the employment data we will also get a look at the Beige Book, the anecdotal evidence the FOMC will use at the next meeting.

While it is difficult to predict the pace of developments, the lame-duck session of Congress will deal with the extension of the Bush-era tax cuts.  There will be more posturing before the final voting.

I continue to see trading versus the dollar as a key factor.  It will be a very positive sign when the inverse dollar/stock correlation breaks down, as we know it eventually will.

Finally, the EU and the IMF already announced an assistance package for Ireland.  It is larger than expected by most and does not require a change in corporate tax rates.  This is good news, but it will be received with skepticism.

Investment Posture

I continue to respect the neutral model reading, so I am cautiously looking for dips to buy in new accounts.  I still expect some very good news out of the lame-duck Congress, with the potential for a nice year-end rally.


Originally published at A Dash of Insight and reproduced here with permission.