Weighing the Week Ahead: Questions Answered at Last

After many months of uncertainty, there is now some clarity.  Many challenges have either been met or now seem less daunting.  Last week provided important fresh evidence on politics, public policy, the economy, and the market. 

I will have my regular review and predicitons, but first, a little background.

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

Last week may have been the most important of the year in terms of resolving questions.  There is an axiom that the market hates uncertainty.  Much uncertainty was eliminated, and it was mostly in a market-friendly direction.

The Good

There was plenty of news last week.  It mostly met or exceeded market expectations.

  • The election.  Let me start with my regular reminder to readers to be political agnostics.  In pointing out the market-friendly results, I do not mean to insult Democrats or fans of President Obama.  My points are about the market, not about politics.

The GOP victories in the legislature have had an instant impact on Obama positions, including a willingness to negotiate on the extension of Bush-era tax cuts.  While I have been predicting this for several months, it is news for many.  The Barron’s summary of effects is here and mine (before the election) is here.

The election extended to the state level, altering the business climate and future legislative alignment in many states.

There was a change in perceptions.  Before the election we heard repeated reports that businesses would not hire because of uncertainty about regulations and taxes.  In Friday night’s Kudlow episdode Jeff Matthews, one of our featured sources, highlights the importance of this effect.  He uses his knowledge of business gained through conference calls to emphasize the business perceptions.

 

  • The Fed.  There was plenty of uncertainty about what the Fed would do, despite the highly-publicized QEII.  The actual announcement was in line with expectations, so why do I see this as “good.”

First, the Fed did a good job of explaining and eliminating uncertainty.  Chairman Bernanke took the unusual step of providing additional explanation in an op ed piece the next day.

Second, the best evidence is the QEII will probably help and is unlikely to hurt.  Many pundits who want to look smart do so by criticizing the Fed.  Some think that the Fed is acting when the economy is already rebounding nicely.  Others think that the QEII policy is inadequate to deal with deflation.   Investors who want a real edge should carefully read Bob McTeer’s article, explaing why Monetary Policy Easing is Nothing to Fear.

I am struck by the difference between the logic offered by Bernanke and McTeer and the slogans used by most of the critics. In particular, the critics who  sloganize about debasing currency and printing money seem not to have noticed the modest growth in the money supply.

Whatever your position on QEII, it is another piece of uncertainty that has been removed.

  • Job Growth.  Friday’s employment report was an upside surprise for most and especially for me.  The recent economic data, especially the ISM reprorts, have been better than expected.  The October job gains, including growth in hours worked and other “internal” indicators, is a sign of improvement.
  • No “double-dip.”  The ECRI now emphasizes that a double-dip recession is off the table.  Regular readers know that I am not surprised, having shown the error in the outsider’s analysis of ECRI data.

The Bad

The economic news was basically good, but there are always some negatives.

  • Initial jobless claims moved slightly higher, and remain at levels that do not signal improvement in the overall  employment picture.
  • The jobs report was still far from what is needed.  A gain of 150K jobs is little more than what is needed to absorb new workers.  Cutting unemployment will require gains of twice that size.
  • The earnings beat rate was much lower.  The overall Q310 news is still good, but now is closer to the historic norm.  See Bespoke Investment Group for earnings coverage and the expected great chart.

The Unnoticed

There was something exciting in Friday’s trading.  After many months of a market where all sectors traded in a correlated fashion, inversely with the dollar, Friday was quite different.

On Thursday many observers attributed the market gains to a “delayed reaction” to the Fed announcement.  A more logical explanation was that the dollar had moved lower (something else that might be related to QEII).  On Friday the dollar regained Thursday’s losses, but the market held the gains.  Furthermore, there was a distinct change in the pattern of sector trading–diversity.

This is a very healthy development.  As my research has demonstrated, long-term stock prices are helped by a strong dollar.  There is also more opportunity when stock and sector analysis is rewarded instead of everything trading in a lockstep “risk on, risk off” fashion.

The Week Ahead

There will be plenty of political posturing in the wake of the election.  I am looking for an early sign of some compromises, especially on tax cuts.

Some of the news will come from the Obama trip to Asia.  There has already been an announcement on a trade deal with India.    This reflects some agreements that business has been seeking for two years.  It bears watching.

The economic data this week is less important.  Trade data will have currency and GDP implications.  Michigan consumer sentiment is a good coincident indicator.

Technical analysts will be watching for a Dow Theory signal – -new highs in the DJIA and the Dow Transport Index.

Meanwhile, I am still watching the dollar, and hoping for a break in the inverse correlation.

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 remain bullish this week.  With few sectors in the penalty box, there are more attractive ETF choices in addition to many low P/E stocks with good yields.  We continue our multi-week bullish posture in the weekly Ticker Sense Blogger Sentiment Poll.   Here is what we see:

  • 75% of our 55 ETF’s have a positive rating, down from 87% last week.
  • 27% of our 55 sectors are in our “penalty box,” still good, but up from 27% last week.  This means that there are many attractive sector and stock opportunities, and a better than average level of risk.
  • Our universe has a median strength of +12, down from +28 last week.

The picture is a little more cautious than it has been in recent weeks.  For trading accounts, we had full exposure during the past week, continuing to catch the recent rally.

[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.]

Thinking Ahead

To think ahead, you need to start with historical perspective.  If you are open-minded, accepting facts whether bullish or bearish,  you must have noticed the positive changes in the last few months.  One-by-one, the list of worries — including recession, skepticism about earnings, the Hindenburg omen, political uncertainty, the head-and-shoulders pattern, etc. — has been reduced.

Is it a world without worry?  Of course not.  The employment and housing problems remain paramount.  If there were no problems, we would already be at Dow 20K.  Potential investors who wait to act until all problems are solved will wind up buying at Dow 20K.

On balance, the investment world has become much more attractive.  Meanwhile, stocks prices have only just regained the pre-Lehman levels of 2008.


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