A Dash of Insight

Weighing the Week Ahead: Are You Ready for Some Fedspeak?

oldprof — 2013-05-18T21:19:34-05:00

Ready or not, we should expect a week dominated by an even greater focus on Fed policy. There are four reasons:

The economic data calendar is very light;
Earnings season has ended;
Many will be heading for the exits early, anticipating a holiday weekend; and finally
Bernanke testifies on the economy before the Congressional Joint Economic Committee. There will also be other Fed speeches and the minutes of the last FOMC meeting.

What should we expect?

Fedspeak is described by former Fed Vice-Chair Alan Blinder as "a turgid dialect of English." In the Greenspan era, the Fed Chair was intentionally ambiguous. (Blinder, who favored a more open exchange, did not last long in the Greenspan era). In the Bernanke era there is supposed to be more transparency. There certainly is more open disagreement among the FOMC participants.

Two Viewpoints

Among market participants there is widespread sentiment that current asset prices of all types, and especially stocks, are the result of worldwide QE. These observers are ready to head for the exit at the first sign of any change in Fed policy. This perspective has been the most popular approach for several years – right or wrong.

Some others regard stock prices as pretty normal, especially since a U.S. recession seems to have been avoided. It is the reduction of fear that supports the rally. The Fed has been relevant in reducing recession chances, but the market rally reflects improvement in fundamental factors – reduced risk and stronger earnings. Most readers would be startled to learn how much negative sentiment is still reflected in current stock prices. Ed Yardeni looks at forward earnings in much the same way I do. Here is a chart showing a normal mean reversion in multiples. If you adjusted for inflation and/or the potential for other investments, we would be talking a market valuation at least 30% higher.

My fearless forecast is that none of the news on Wednesday – either from Bernanke's testimony or the FOMC minutes – will resolve this debate! It will provide something for the parade of pundits to talk about.

I have some thoughts on what to expect from the Fed which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"

There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.
In contrast, I highlight a smaller group of events. My theme is an expert guess about 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.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

This was another good week for the stock market, but there was only mild support from the data.

Retail sales were strongly positive. Last week I wrote that we would be focusing on the consumer, and this was a surprise for me. Steven Hansen has a very nice analysis at Global Economic Intersection. This analysis has charts and many comparisons, avoiding the controversies of the various adjustment processes. Take a look!
Energy exporting from the U.S. is promising. See the first-rate discussion at ft.com.
Building permits showed strong growth. Regular readers know that I favor this as a leading indicator on housing. So does Scott Grannis.

Michigan sentiment was amazingly strong. This is very good news about consumption and employment. Here is the helpful chart from Calculated Risk. You can see the improvement to a crucial level. Check out the full article for further analysis.

The Bad

There was plenty of bad news.

Gas prices are moving higher. This is a surprise, since the trend in both oil and gasoline had been lower. Automotive Fleet covers this news – up six cents last week. Illinois is near the top of the list in prices ($4.20 – 4.25 here in the Chicago burbs) partly because of refinery problems. In my annual pickup trick for my son, there was a 65-cent swing in prices if you drove an hour south. (Derek has been an occasional contributor on my blog. Please indulge me in a bit of fatherly pride at his 4.0 as he completed his Junior year at Illinois).
Household debt is lower – by 11.4% from the 2008 peak. Put another way, the U.S. consumer is reducing debt at the same time that overall consumption has been solid. See the details from Jeffry Bartash at MarketWatch.

Initial jobless claims spiked to 360K, about 30K higher than expectations. This is a noisy series with challenges related to seasonal adjustments, so everyone watches the four-week MA. It is still bad news, and worth special attention in the next few weeks.
Housing starts declined sharply. Calculated Risk has this story and also a more comprehensive interpretation. The housing starts are quite disappointing, but distorted a bit by the sharp decline in multi-family units. Here is a good chart showing both types:

The Neutral

Sometimes it seems like we are running in place. I always read and enjoy the high frequency indicators from The Bonddad Blog. New Deal Democrat's weekly post covers many indicators beyond those highlighted here. At the moment, his conclusion is similar to my overall picture – a period of sluggish growth.

The Ugly

The IRS is the clear winner of this week's "ugly" award. The actions of this agency managed something previously thought to be impossible – unifying Congress! If you watched or read the testimony of IRS officials – can't remember, not sure about notes, etc. – do not try that at home! IRS auditors are not likely to be very forgiving when records are missing.

If this turns out to have some reach into the upper levels of the Obama Administration, it could have some market effects.

Man Bites Dog

S&P has downgraded Berkshire Hathaway. I had to recheck the headline! The guys who were so wrong about subprime? Who downgraded US debt after the debt ceiling debate, even though an agreement was reached – just because they did not like it? No one elected these people to dictate the public policy agenda for us. There is a very nice Reuters story on this topic, which I recommend.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverage of the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating. It is time for a fresh look at his "Big Four" chart.

Doug reviews the latest (umpteenth) change in the ECRI methods, showing why there is nothing magical about nominal year-over-year growth in GDP of 3.7%. Short answer: low inflation distorts the analysis.

The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. After a brief move to "neutral" about a month ago we switched back to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure has moved lower, so we now have more confidence in short-term trading.

[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 ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings little in the way of economic data.

The "A List" includes the following:

Initial jobless claims (Th). This is the high-frequency indicator on employment. Interest will be especially high after last week's surprise spike.
New home sales (Th). Interest is greater than usual. Many are counting on strong housing data to offset the sequester, and expectations are high for the spring.
Existing home sales (W). See above.

The "B List" includes the following:

Durable goods (F). Interesting but volatile series.
FOMC minutes (W). From the May 1^st meeting.
FAFA home prices (W). These are the prices from the regular homes in the government market.

Various Fed speeches, highlighted by Bernanke's testimony on Wednesday morning, just after the market open.

Trading Time Frame

Felix has continued a bullish posture. Even with a brief move to a "neutral" overall rating, Felix continued to find at least three attractive sectors. The positions were pretty defensive until about ten days ago. Felix has picked up the shift to cyclical stocks and technology, and also the move to financials. The trading picture is attractive and broadly-based.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

What NOT to do

Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. I highly recommend the excellent analysis by Kurt Shrout at LearnBonds. It is a careful, quantitative discussion of the factors behind the current low interest rates and what can happen when rates normalize.

Other yield-based investments have a similar or greater risk profile. As David Kehohane of FTAlphaville notes, even junk bonds are now yielding less than 5%!

Find a safer source of yield: Take what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked for over two years and continues to do so.

Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on new events and not enough on earnings and value.

Three years ago, in the midst of a 10% correction and plenty of Dow 5000 predictions, I challenged readers to think about Dow 20K. I knew that it would take time, but investors waiting for a perfect world would miss the whole rally. In my next installment on this theme I will deal with the logic behind the prediction. It is important to realize that there is plenty of upside left in the rally, as Barron's notes this week in the cover story, We Were Right!

Get Started

Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. There are many attractive stocks right now – great names in sectors that have lagged the market recovery. You can imitate what I do with new clients, taking a partial position right away and then looking for opportunities.

We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).

Final Thought

What should we expect from this week's Fed news?

I expect Bernanke to re-emphasize the commitment to economic growth. The markets have clearly not gotten the message. The Fed is determined to avoid deflation. There is little inflation risk, especially using the Fed's preferred measure, the PCE index. The public consensus is that stimulus will be gradually withdrawn as the economy improves. Why not accept that message? Those who have taken the Fed at its word have done much better than the perpetual skeptics.

Here is another perspective from Jim O'Neill, economist and former Chairman of Goldman Sachs Asset Management. I especially like sources who are not selling a particular product, and so should you.

"Our stock markets seem to be enjoying themselves. Many ascribe the robust performance of stocks as nothing more than the consequence of friendly monetary policies all over the world. While I am sure this is playing its part, it was just as fashionable to argue the same easy monetary policies were also fuelling the commodity rally some time ago, so perhaps it isn't that simple.

Maybe something a bit more substantive is happening. After the pleasant surprise of +0.3pc real GDP in the UK in Q1, many of us were braced for the resulting setback, which would follow the pattern of the past couple of years. But while it is early days, quite a bit of recent economic news has continued to be on the positive side.

While much of the eurozone continues to struggle, US performance remains encouraging; a housing recovery and a competitive boost from cheaper domestic energy seem to have underpinned the improvement.

And, while we don't export a great deal to Japan these days, the improving mood of the Japanese consumer to the country's monetary and fiscal boost suggests that a number of other economies will take heart. It is too soon to be singing in the streets, but the signs are looking better than they have for a while."

This really nails it. Those who have been completely wrong about the economy and the stock market have blamed Fed policy for every move in every market.

Do you remember when the price of tacos was blamed on Bernanke?

I started to explain this with my controversial article on the flaw in David Tepper's analysis. I accept Tepper's conclusion, but I object to those who take shortcuts in economic analysis. I'll have more on this theme.

Investment Implication

I understand that most of the world is programmed for a knee-jerk response to any news about the Fed. Eventually, the actual effects – both on the economy and corporate earnings – will prove to be more important. Some think that they can anticipate and "game" the reactions of others. That might be worth trying. But shouldn't we start with a better understanding of reality?

If you get the fundamentals right, you will be a successful investor.

A Flaw in the Tepper Analysis

oldprof — 2013-05-14T21:26:45-05:00

When David Tepper speaks, the market listens.

In Autumn, 2010, Tepper, the highly successful billionaire hedge fund manager, explained that for stock investors, the Fed had your back. Using options jargon he said that there was a "put" (downside protection) regardless of what the economy did. While causation is always hard to prove, the comments came on a 2% rally day in the market and the rally continued from there.

Today Tepper went public again, with a very bullish prognosis. A key part of his analysis was that the Fed purchases under QE, even if tapered off, would be greater than the net new issuance of debt by the Treasury. You can check out CNBC's site to see the entire interview.

Tepper goes on to discuss the historic highs in the equity risk premium and why this represents a major opportunity for investors in stocks.

Background

There is a sharp divide in the analysis of this topic. I want to emphasize that readers are consumers of this analysis – and so am I. The difference is that I have some training that helps me figure out what is silly and what is helpful.

On one side we have "the bond guys." These are investment firms that are selling bond funds and also the research firms that cater to the bond community. Think Gross and Gundlach for the first group, and Lacy Hunt and Jim Bianco for the second group. They are on a mission. There is a world that has been widely embraced in the trading community. The basic idea is that the Fed prints some money and hustles out to buy government debt. They describe the world as if it were a market with two counter parties. The results of this transaction are somehow reflected not only in bond prices, but also stocks, oil, gold, and tortillas. Sheesh!

On the other side there are those who are more thoughtful in their analysis. This week we have seen some great commentary.

Brad DeLong explains why the big-name hedge fund traders have taken the wrong side of the trade;
Josh Brown does a careful analysis of the incremental steps involved in QE tapering. This is market savvy applied to the current economic questions, so it deserves respect.
Michigan economist Miles Kimball explains why QE has worked and suggests how to measure the impact. On the way he refutes Martin Feldstein's WSJ op-ed piece.

My Contribution -- Reality

My perspective is a little different: I am trying to draw together the very best sources and conclusions with an emphasis on finding the best investments. From both formal training and experience I know about both economics and markets.

I am shocked by what I see.

The prevailing discussion of bond trading is that the Treasury is selling and the Fed is buying. The result is a simplistic depiction of a two-party market with resulting stupid conclusions. This is what led to Bill Gross foolishly asking "Who will buy Treasuries when QE II stops?" The flawed two-party model continues.

The reality is that the following:

The average daily trading volume in Treasuries is $550 billion.
The Fed participation is less than one percent, even on a big day.
There is plenty of appetite for debt. Regular auctions do not include the Fed, and they have a high bid-to-cover ratio. Strong evidence!

Consider it as supply and demand on a daily basis. It is a huge market. The Fed adds to demand, probably reducing the price elasticity of the demand curve. It is something like this (diagram borrowed from a helpful and educational site).

For QE buying, look to the chart on the right. The demand curve has shifted a bit, leading to a somewhat higher price, higher quantity, and lower yield than would otherwise have occurred.

For the QE exit, look to the chart on the left. The Fed will be a seller, slightly reducing price and increasing quantity.

Failing to consider the Fed purchases (and future sales) within the context of the overall market is a simple mistake. One can argue about the shape of the curve and the exact magnitude of the impact, but it is not just a matter of comparing net issuance to Fed purchases or sales. The changes are relatively modest.

The prevailing analysis is so bad that I would call it a blunder, albeit a knowing one on the part of some.

Conclusions

There are some obvious implications for your analysis of QE and the effects:

The effects of FED QE accomplishments to date are dramatically overstated. The QE policies moved rates a bit lower, but the asset markets also reflect earnings – both current and expected. The Fed's internal estimate, as of last autumn, was about 1% on the ten-year note. We can all speculate what this meant for the job market.

"How effective are balance sheet policies? After nearly four years of experience with large-scale asset purchases, a substantial body of empirical work on their effects has emerged. Generally, this research finds that the Federal Reserve's large-scale purchases have significantly lowered long-term Treasury yields. For example, studies have found that the $1.7 trillion in purchases of Treasury and agency securities under the first LSAP program reduced the yield on 10-year Treasury securities by between 40 and 110 basis points. The $600 billion in Treasury purchases under the second LSAP program has been credited with lowering 10-year yields by an additional 15 to 45 basis points.¹² Three studies considering the cumulative influence of all the Federal Reserve's asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield.¹³ These effects are economically meaningful."
The entire mechanism for analyzing QE effects is mistaken. Why continue to listen to those who have been wrong for years? Maybe a new model is needed.

There is also the flip side.

The ending of QE is not as scary as portrayed by most "pop economist" pundits.
Since the initial impact of QE was an "overbid" the winding down will be as well.

Investment Implication

David Tepper is right on all of the key points.

He is accurate on Fed policy.
He is accurate on overall market valuation – the equity risk premium.
He is accurate on the right posture for most investors.

Why do I disagree? I am not trying to pick nits. I mean to analyze what is actually happening, explaining why investors should not fixate on Fed policy.

Tepper is meeting the critics on their own terms – discussing net debt, even if that is the wrong measure. He is catering to the popular mistaken belief. I disagree with his analysis, but not the investment implication.

[Update - description of Fed exit impact on quantity corrected - thanks RS.]

Weighing the Week Ahead: Are Consumers Ready to Buy? What about Housing?

oldprof — 2013-05-11T22:05:01-05:00

The economic recovery, to the surprise of nearly everyone, has been consumer-driven. This has occurred despite increased savings and an overall improvement in household balance sheets. Businesses have been cautious to invest and to hire. State and local governments have been slashing spending and employees.

I expect a week with a consumer focus. It starts with data on retail sales, expected to be weaker from the payroll tax increase and lower gasoline spending. It ends with the important indicators on housing. There are several possible themes this week, but I expect the role of the consumer to be at the forefront of the discussion.

If you read but one piece in preparation I recommend the chart and data-filled speech from Fed Governor Elizabeth Duke, alertly reported at Global Economic Intersection. Here is a sample of the many good charts, but it is only one theme out of many.

I have some thoughts on housing and the consumer which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

This was a good week for the markets, but it was a light week for data. The story was mixed.

The projected US budget deficit for fiscal 2013 is now more than $231 billion lower than for 2012. (via the CBO). This is due to a combination of relatively modest spending increases and much higher revenues. It will provide some additional flexibility for policymakers to negotiate more comprehensive solutions.
Banks are easing lending standards (via Calculated Risk). This is necessary for the widely-noted increase in the Fed's monetary base to turn into actual "money printing."
Hotel bookings are strong (via Calculated Risk). That coincides with my personal experience!

The Bad

The thin data week included a little bad news. Feel free to add in the comments anything you think I missed!

The improved debt picture comes at a cost. Menzie Chinn discusses the impact of austerity in general and the sequester in specific. It is a lower path to reduced unemployment and slower economic growth. Most estimates of Q2 GDP growth have been lowered as a result.
The earnings beat rate dropped significantly this week, and the revenue beat rate is even worse. Here is one of the summary charts from Bespoke (check out the full article for the full story). And see Paul Vigna at the WSJ for a great discussion of specific factors.

The Administration is looking for volunteer funding to implement ObamaCare. Good luck with that!

The Ugly

This week's ugly award is another Twitter effect. While not as big as last week's example, it shows how vulnerable we remain to rumors. This time the rumor hit on Thursday afternoon. The story was that John Hilsenrath, the well-connected Wall Street Journal reporter on the Fed beat, would release a story about the ending of QE. The story was expected to hit about an hour before the market close.

Stocks sold off on the rumor about a rumor. You could follow the discussion on Twitter -- a place where people explain market moves, but it also promotes moves for those who have advance information – even if they call it a rumor. You can check out the history and retweets here.

The substance of this rumor was pretty silly. The Fed members are all off giving speeches. They do not all agree. Hilsenrath's job is to write about this. Anyone paying attention knows that no policy change is imminent. You trade this stuff at your peril, as I wrote here. And here is the final WSJ article, coming out after the close on Friday.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

This week's award goes to Joe Taxpayer (with a HT to Josh Brown) for exposing another popular example of chart deception, over-fitting two data series by massaging the scales. Without the distortion there would be no nice-looking fit. Well done, Joe.

My problem is that I cannot award a Silver Bullet to someone refuting a straw man. It is much better if the winner identifies the source of the misleading information. I was not going to use this, but the misleading information was (not surprisingly) found at the most common source – ZH. While the chart is offered without comment, the "rating" is 4.5 from the enthusiastic crowd at that site.

[Question for readers: Should I only award the Silver Bullet when the author identifies the source of the error?]

Nominations are always open for more Silver Bullet candidates.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

Georg Vrba's model sees a decrease in unemployment to 6 percent in 2015, with a possible recession in early 2016. Georg has an array of interesting models on different themes – all with strong results, combining testing and real time.

Here are two significant developments since ECRI's initial recession call in September 2011:

The S&P 500 is up 43.8%.
The unemployment rate has dropped from 9.0% to 7.5%.

Doug also reviews the latest (umpteenth) change in the ECRI methods, showing why there is nothing magical about nominal year-over-year growth in GDP of 3.7%. Short answer: low inflation.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. Over the last few weeks we have varied between bullish and neutral. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings have improved significantly over the last two weeks. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. Since that measure remains elevated, we have less confidence in short-term trading.

The Week Ahead

This week brings plenty of data.

The "A List" includes the following:

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
Building permits and housing starts (Th). Especially important right now.
Michigan sentiment (F). Still not at recovery levels, and pressured by taxes and lagging employment.
Leading economic indicators (F). This is still a favorite for some.

The "B List" includes the following:

Retail sales (M). Expect a slow start to the week due to reduced gasoline purchases and lower car sales.
Industrial Production (W). Continues to be important in tracking economic growth.
PPI (W). The headline numbers will be negative with a small positive for core (ex food and energy).
CPI (Th). See PPI. No inflation pressure on the Fed.

Earnings season winds down. The regional Fed indexes matter only if there is an outsized move. The Fed members are on the speaking circuit, so expect plenty of (conflicting) signals from those sources. It is not like the Greenspan era, when members pretty much stayed "on message."

It is also options expiration week, adding to volatility.

Trading Time Frame

Felix has resumed a bullish posture, now fully reflected in trading accounts. It was been a close call for several weeks. Despite the move to a "neutral" overall rating, Felix continued to find at least three attractive sectors. The positions were pretty defensive until a few days ago. Felix has picked up the shift to cyclical stocks and technology.

To illustrate the change I have opened up my weekly column at Wall Street All Stars. This shows the entire rating list as of Wednesday, as well as my featured ETF for the week. (I am enjoying my participation with this group – especially the stock ideas. There are a many interesting suggestions from the community. One or more contributors will join in to answer questions).

As an additional update for WTWA readers, Felix added QQQ to the buy list on Friday. This is the only broad market ETF with a solid rating.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

The danger to avoid

Investments traditionally regarded as safe are now among those with the greatest risk. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. I highly recommend the excellent analysis by Kurt Shrout at LearnBonds. It is a careful, quantitative discussion of the factors behind the current low interest rates and what can happen when rates normalize.

Other yield-based investments have a similar or greater risk profile. As David Kehohane of FTAlphaville notes, even junk bonds are now yielding less than 5%!

A safer source of yield --what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%, with risk far lower than a general stock portfolio.

Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on new events and not enough on earnings and value.

For the investor with a reasonable time horizon, there are many fine opportunities. While some stocks and sectors are overvalued, there are still many good choices. BreakingViews has the story:

Todd Builione, president of JPMorgan-owned hedge fund firm Highbridge Capital Management, said at the SkyBridge Alternatives conference on Wednesday that cyclicals now present a historic opportunity. They may be vulnerable to economic winds, but for now there's a big discount to compensate investors for that risk.

Final Thought

Will the consumer step up on housing?

New Deal Democrat at The Bonddad Blog does a comprehensive update of leading indicators. There are many good charts, but here is one that I closely follow – building permits. There is a nice trend, but a recent stutter.

It is a crucial question. Calculated Risk is the best source on all things housing. Bill thinks that the bottom is in, and is following various indicators for the exact timing of the rebound. Check out his analysis from one month ago and join me in watching this month's data.

Moody's Analytics' Mark Zandi sees housing leading a rebound in employment. The WSJ quotes him as follows:

Mr. Zandi said building should return to normal precrisis levels of 1.8 million homes built per year from 900,000 in recent years. He added that every single-family home that is built generates 4.5 new jobs, every multi-family property creates two jobs, while the activity creates demand for a multitude of building materials and services.

Whether or not you agree with these three sources, you know what to watch. And keep in mind that you cannot possibly do worse than Wall Street "strategists" who have missed the last 16% move (via Josh Brown) with their lowest stock allocation in history. If you have trailed in your investment performance, you are not alone.

Earnings Season and the Dog that Did Not Bark

oldprof — 2013-05-08T20:38:53-05:00

As the Q113 earnings season reaches its close, there is a consensus around many conclusions:

Earnings are growing at a rate less than the stock market. The P/E multiple is higher. Is this justified?
Earnings exceeded expectations only because those expectations had been reduced. Is this a charade – the dance of the Wall Street analysts?
Revenue was very disappointing. Companies were beating on the bottom line while missing on the top line. Can this continue?
Corporations presented varying levels of confidence. Some saw a strong future, while many were more cautious. What does this tell us about the future?

The actual reports and the conference calls included plenty of discussion of these factors. Individual stocks gained or lost based upon the market reaction.

The issues are all valid. Investors should be skeptical about earnings, especially about projected growth. I always question whether current results flow from extraordinary measures. Can the success continue?

You also need to beware of biases. In the '99 bubble era" there was a distinct bias toward optimism. Today it seems different. Many CEOs choose not to exude excessive confidence when nearly everyone is worried.

How Should Investors React?

All of the conclusions and questions are good ones. We study every potential stock purchase carefully, and so should every individual investor. If the company report does not verify your reasons for owning the stock, it is time to move on. I use the Seeking Alpha transcript search – a free resource for many conference calls – when I am unable to listen in person.

If the company is performing according to plan, it might be acceptable to ignore the market reaction, or even to buy more.

The key point is to test performance against your expectations and your reason for owning the stock.

The Dog Not Barking

Meanwhile, there are many investors who are not really monitoring earnings season because they are out of the market. They are not evaluating current holdings, nor are they shopping for any new ones.

Why not? They foolishly rely upon Tobin's Q.

They have read about a Nobel Laureate (a great source, whose books I used to assign in class) or a perma-bear or two who have made a cottage industry out of selling these updates. They always warn you not to buy stocks. What would it take for this indicator to flash a "buy" signal?

The reason is that the underlying concept relates to a different era – manufacturing stocks and replacement costs. It has no relevance to companies like Google or IBM or Apple, or nearly any service-oriented firm. Try to apply it to the Buffett portfolio's insurance stocks. Or Coke.

So check it out. Did any earnings season discussion of a specific company cite Tobin's Q? I did not see any. I cannot remember one. It was Sherlock Holmes and the dog not barking.

If you cannot find an example either, maybe it is time to put this concept to rest.

Reader Challenge

With a little thought, my guess is that readers can think of one or two other market valuation methods that are completely unmentioned during earnings season. I didn't see anyone discussing a company's earnings from ten years ago, but there was plenty of talk about next year.

If you put these misleading ideas to rest, you will be free to join us in finding attractive investments.

Dow 20K – Halfway There

oldprof — 2013-05-07T20:36:22-05:00

Three years ago I wrote one of my most controversial posts: Dow 20K.

The Dow had been toying with the 10,000 mark, after a 10% correction. The news from Europe seemed to be terrible, and everyone was on board with the domino theory. We were in the midst of the worst May since 1940. The most bullish of market pundits were calling for upside of 8% or so. Meanwhile, there were plenty of highly visible pundits calling for Dow 5000 – or worse.

Something was seriously wrong with the media perspective. Investors were getting a huge dose of the downside risk, complete with numbers, but the upside story was more difficult to explain. I wanted to challenge readers to step back and to reexamine their biases.

I suggested the simple proposition that the market was more likely to double than to be cut in half. It was the sort of thing that Peter Lynch said in days gone by, and everyone accepted it as obvious. Something changed in 2008. We entered a climate of negativity on all fronts, and we still have not emerged.

I am accustomed to responses on the order of "Miller, you idiot!" When I started to write the blog, some seven years ago, I was a bit sensitive, trying to persuade every objector. At some point I realized that whenever you have something important to say, there will be many who disagree.

To appreciate what happened three years ago you need to look at the comments and responses, especially on Seeking Alpha. Hardly anyone agreed with my proposition, and most did not understand the objective. I did not give an exact time frame for the forecast, but I did say "faster than people expected" and "less than ten years" which actually implied an annual growth rate in nominal terms of only about 7%. Even these modest statements were seen as bold and controversial.

I am going to follow up on this post with some analysis of what has fueled the rally.

Most investors have missed the first leg of the rise to Dow 20K. Many will stay on the sidelines, listening to the same tired reasons from the same inaccurate pundits. One guy scolded me for ignoring the Shiller P/E and recommended reading Grantham and Hussman. Today's comments on my work often suggest much the same.

Since I know that people will not really click through to the old post (although that is how to see the fun!), I am going to reproduce here much of what I wrote.

"Someone needs to say this:

Dow 20K.

The fear mongers abound in the financial media. TV and online ratings seem to go to those helping to peddle fear and sell gold or structured annuities (with high commissions attached). Every individual investor I meet is scared silly. They do not realize what is at stake.

For the mainstream media, it is all about ratings. They have all learned that fear sells. Attacking Obama, attacking Bernanke, attacking European leaders, explaining government policy as if it were the family budget --- it all works. The big-time media have garnered page views and sold papers.

Even when they attempt to show "balance" they have someone warning about Dow 5000 and the "bull" saying that stocks will go up 8% this year! Is it any surprise that watchers are scared witless?

Investors need to understand that they are missing more than an 8% move. Stocks will double. When will they get on board? Do they have a plan?

The Proposition

Let us attempt to restore some balance.

There is undue publicity given to Dow 5000. A 50% decline has happened only twice in history. The first time was in the Great Depression. The second time was when people incorrectly believed that the fall of Lehman would lead to another depression. As we now know, that was incorrect. March, 2009 was a buying opportunity. What about now?

Here is the proposition.

The Dow will double before it is cut in half."

More - -much more – to come on this theme. The individual investor faces the very same challenges.

I do not know whether the current level of Dow 15K will hold or not in the short term. I hope that readers realize that is not the point.

Weighing the Week Ahead: New Leadership for Stocks?

oldprof — 2013-05-04T22:11:17-05:00

For several weeks I have been monitoring a developing change in the US equity markets. There is a growing perception that some of the "safe" assets may not be so safe. There is a corresponding realization that the "risky" choices might not be so risky.

Some see this as a sign of danger. Cam Hui, our "Humble Student of the Markets," notes the general market trend, concluding, "For traders, it may be premature to get overly bearish without some catalyst or trigger." He is concerned, however, that the defensive leadership is a sign of weakness.

Prestigious BCA Research sees it as a "changing of the guard" even if the market moves somewhat lower. They provide a table of sector results in corrections that do not include recessions.

Goldman Sachs sees it as an opportunity.

"Going into May, sectors best positioned from a growth and value perspective are financials, industrials, information technology, and materials, according to a Wednesday note from Goldman Sachs Group Inc.

From a value perspective those sectors are certainly underperforming. Tech and materials the biggest laggards on the S&P 500 Index SPX +1.05% with year-to-date gains of 3.5% and 4.6%, respectively. Industrials and financials are also in the bottom five performing sectors year-to-date with gains of 8.6% and 13.3%, respectively."

Josh Brown, who deserves special respect because he is on the side of the individual investor, underscores how far the trend has gone. Bond funds are now buying stocks – in record size.

I have some thoughts about leadership. I will stifle my comments on political leaders and stick to market leadership! Check out the conclusion for my take. First, let us do our regular update of last week's news and data.

In contrast, I highlight a smaller group of events. My theme is an expert guess about 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.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

The economic data this week was a mixed bag, but expectations were pretty low.

Bullish sentiment remains low. The team at Bespoke is surprised – especially given the new market highs.

Initial jobless claims declined to 324K. This is the lowest since 2008. While it is definitely good news, job losses are only half of the story. We also need job creation.
Home Prices are moving higher according to the Case-Shiller index. This is the slowest of the various measures, but it is coming along according to the Calculated Risk analysis. (Contra – Shiller himself remains skeptical. Investors must decide whether he is a leading or lagging indicator).
The Jobs Report was Positive. I am scoring this as good news, partly because of the negative whisper expectations. The BLS estimate beat my own cautious forecast. It seemed to hit the sweet spot of moderate economic growth and continued Fed stimulus. Before we celebrate too much, there are a few cautions.
- Hours worked. This bothers me. I do not like it when there is a soft number on overall jobs but an increase in hours worked. We must be consistent. The 0.4% decrease in hours is like a loss of 500K jobs or so. There is something going on -- shift to lower-paying jobs, consulting, whatever.
- Structural Issues and Labor Force Participation. These are key topics. Mark Thoma highlights commentary from two leading sources (both of whom—and Mark -- were at the recent Kauffman Conference). I respect their commentary, and so should you. Dean Baker cautions on the composition of the changes. Tim Duy recommends following long-term trends.

The Bad

The data this week included some significant bad news.

Rail traffic is weak, up only 1.6% y-o-y (via Cullen Roche).
ISM manufacturing increased to only 50.7. ISM research shows this to be consistent with real GDP growth of 2.7%, but many observers think this is a bit too high. It is on my summer research agenda. Meanwhile, here is a good chart from Calculated Risk, where you can also get more analysis:

Personal income growth was only 0.2%, below expectations of 0.4%. This is an important economic indicator.
Earnings reports show bottom line beats, while top-line misses. This leaves us wondering whether the current rate of earnings growth can be maintained.

The Ugly

The bogus tweet about White House bombings gets this week's "Ugly" award. There is a race encouraged by social media. The fastest way to find out about anything is Twitter. I use it, and so do you. There is an abundance of raw information, which is useful on many fronts. The problem comes when the high frequency traders pounce on "breaking information." Many individual investors unwisely believe that they can "protect" their investments with standing stops. It is not so easy, as I explained in this post.

If you are an individual investor and attempting to do active management of your portfolio, you really need to think about this issue. There will be special attention to this in the wake of the three-year anniversary of the "flash crash."

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

This week's award goes to Doug Short for exposing the most recent ZeroHedge data deception. As usual, whoever was writing as "Tyler Durden" did not give a link to the alleged David Rosenberg comment, so we do not know if it is accurate. I get frequent questions from readers about ZH analyses and conclusions. The stories usually combine a smidgen of real data with severe distortion. This makes them difficult to refute, especially when the story appeals to the preconceptions of most readers.

The latest installment takes a single month of real income, distorted by anticipated tax changes, multiplies the result by 12 to "annualize" and make it seem bigger, and then go for the scare. Doug exposes this methodically and carefully. Most readers will not want to consider the full refutation – and that is what "Tyler" counts on.

Noah Smith in How Zero Hedge Makes Your Money Vanish makes a frontal assault.

Zero Hedge is a financial news website. The writers all write under the pseudonym of "Tyler Durden", Brad Pitt's character from Fight Club. Each post comes with a little black and white icon of Brad Pitt's head. On Zero Hedge you can read news, rumors, facts, figures, off-the-cuff analysis, and political screeds (usually anti-Obama, anti-government, and pro-hard money). On the sidebars, you can click on ads for online brokerages, gold collectibles, and The Economist.

The site is a big fat hoax. And if you read it for anything other than amusement, you're almost certainly a big fat sucker.

What Noah does not mention is the widespread following enjoyed by ZH – and mostly not "amusement" readers.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

Doug reviews the latest (umpteenth) change in the ECRI methods, showing why there is nothing magical about nominal year-over-year growth in GDP of 3.7%. Short answer: low inflation.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

The Week Ahead

I cannot remember a week that offers less fresh economic data. The pundits may try to make something out of nothing, but I will not – and neither should you.

The "A List" includes the following:

Initial jobless claims (Th). This is the most responsive employment indicator. It is improving, and worth watching.

The "B List" includes the following:

Nothing.

We have passed the peak in the earnings story, but there is still plenty to come.

With the FOMC decision in the rear view mirror, the participants are free to talk – and they will! Expect plenty of Fed commentary and speeches and plenty of over-reaction by the punditry.

Trading Time Frame

Felix has switched back to a bullish posture, but the featured sectors are quite defensive. While the "official" call was neutral over the last few weeks that is based upon the overall ETF ratings. As long as there are three solid sectors to buy, we are fully invested in trading accounts. Felix has remained invested, but in the defensive choices. That means that the model has lagged market performance over the last few days, but at least we stayed invested – and despite plenty of skepticism.

Those who follow Felix have learned a key market lesson: Understand what is working, and follow it!

Investor Time Frame

Each week I write this separate section for long-term investors. Most want to out-guess the market. These are really smart people who are quite successful in their "day jobs." They spend some time online, reading carefully from the leading blogs.

They find themselves scared witless (TM OldProf euphemism). The result is that they rush to anything that has a defined yield, without considering the risk of losing principal.

The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

My general advice to investors differs sharply from that for traders. It also depends upon age and risk tolerance. And please remember that everyone is different!

Take what the market is giving you!

For the conservative investor, this means buying stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%, with risk far lower than a general stock portfolio.

For the investor with a longer time horizon, there are many fine opportunities. While some stocks and sectors are overvalued, there are many good choices.

Final Thought

Can we expect new stock leadership?

In a word, "Yes."

We have experienced a multi-year period of economic skepticism. The US economy has succeeded anyway, and corporate profits have done even better. The Great Recession included a sharp decline, but a gradual rebound. We are still in the mid-innings of this recovery, with the end of the game not in sight.

It is an unusual opportunity to buy stocks that will benefit from an improving economy. Here is some good advice from Pat Ryan at FT Adviser: Buy Cyclical Equities.

Investor sentiment on equities appears to be improving, with inflows to equity mutual funds turning positive early in 2013 for the first time in years, but investors do not appear to have confidence in a true recovery in global economies.

Investors seem to have been forced into equities by the lack of return available in other asset classes and have thus far restricted their search to those equities they expect to show resilience in a potential market downturn.

However, this view has driven the valuations of more defensive stocks, particularly large, well-known companies, to unattractive valuations relative to the overall market.

April Employment Report Preview

oldprof — 2013-05-01T21:28:20-05:00

Recent economic data, especially since mid-March, has taken a turn for the worse. Initial jobless claims have shown fluctuations that defied seasonal adjustment processes.

Just as I (accurately) suggested last month, it is a time for caution.

I will elaborate on my reasoning in the conclusion, but let us first review the expectations for Friday's report.

Background

My preview is different! There are many concepts and facts that you will not see anywhere else. I also try to provide an angle both for traders and investors. I sift through the mythology and the mistaken conventional wisdom.

For many years I have written a regular monthly preview of the Employment Situation Report. I have done extensive research on all of the methods and even visited the stat guys at the BLS to discuss their approach.

My preview gives appropriate respect to the BLS, but also to the leading alternative methods. My best analogy was to a bean-counting contest. The winner was NOT the contestant who was closest to the correct answer. Instead, the winner had to predict the guess of a fellow contestant.

This is what we do every month. We want to know the truth about the economy. Instead of recognizing that there are several good estimates, everyone tries to guess what the BLS will report.

For the full explanation please read this former preview. You will enjoy a laugh along with a deeper look.

Three months ago I recommended that readers should compare the results of the various forecasters, viewing the BLS as a competitor along with others. At some point we know the actual result, so why not consider all of the forecasts. We now have more results, reported in the conclusion.

My main point is simple, but important.

We rely far too much on the first pass, BLS version, and officially certified monthly employment report. It is a natural mistake. We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets. Whenever there is an important question, we all seize on any available information. While we might know the limitations of the data, any concern is briefly acknowledged -- if at all -- and then swiftly put aside.

The Data

We would like to know the net addition of jobs in the month of April.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
The report is revised to reflect additional responses over the next two months.
There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone. Everyone focuses on the birth/death adjustment. This actually accounts for less than 20% of the BLS attempt to estimate job creation.
The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low, as revealed in the most recent report. For the year ending in March, 2012, the BLS estimate was off by about 30K jobs per month overall, and 35k jobs per month on private employment. The January report adjusted for these benchmark revisions.
Early returns suggest that the BLS methods might be running too high by as much as 65,000 per month. See the conclusion.

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. The BLS is actually like one of the contestants, with the full report coming later. The market uses this estimate as "official" and declares winners and losers on that basis. No one pays any attention to the final data, which we do not see for eight months or so.

ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 119K private jobs on a seasonally adjusted basis. In general, the ADP results correlate well with the final data from the BLS, but not always with the initial estimate. In recent months ADP is using an improved methodology with a stronger sample. The objective is to improve the correlation with the final print of the employment data.
TrimTabs looks at income tax withholding data. Their idea is that this is the best current method for determining real job growth. TrimTabs forecasts a gain of 67K. We are moving past the year-end uncertainty about tax law from the fiscal cliff debate, so one would think that the TrimTabs estimate would now be more accurate.
Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate).
Jeff Method. I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at about 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. This is on the summer research agenda – a time when I typically have help from smart people looking for great experience. While the Jeff model is still officially on the sidelines, it once again suggests significantly lower job gains than the other approaches. Put another way, on a long-term historical basis we would not expect gains of more than 100K given the other economic data. Is job growth really leading the recovery? I do not think we have a good grasp on job creation. The BLS tries hard, but their approach lags on this front. Street estimates are generally similar to my method, but few reveal much about the specific approach. These estimates usually adjust for the ADP report.
Briefing.com cites the consensus estimate as 155K, while their own forecast is for 135K. Their private jobs forecast is about 10-20K higher, since the loss of public jobs is a continuing drag.
Gallup has an update to an employment series without seasonal adjustment. They have not been consistently reporting a series that we can follow. I have tried to give this source respect and equal time despite a rather overt bearish and political approach in past commentaries. Why no update on seasonally adjusted unemployment?

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

Focus on net job creation. This is the most important. The big story is the teeming stew of job gains and losses. It is never mentioned on employment Friday. The US economy creates over 6.5 million jobs every quarter.
Failure to recognize sampling error. The payroll number has a confidence interval of +/- 105K jobs. The household survey is +/- 450K jobs. We take small deviations from expectations too seriously -- far too seriously.
False emphasis on "the internals." Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy. In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
Negative spin on the BLS methods. There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment. This is a propaganda war that seems to have ended years ago with a huge bearish spin. For anyone who really wants to know, the BLS methods have been under-estimating new job creation, which was demonstrated in the addition of 350K additional jobs in the benchmark year.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

And most importantly, it would be helpful if anyone would realize that the BLS is just one estimate among others -- and perhaps not the best. The bean counter example illustrates this.

Trading Implications

The first table shows the data from January. The actual net job gain for the quarter was 582K. All of the estimates were too low, and the BLS was the worst.

	Original Employment Estimates - Q2 2012
	*ADP*	*TrimTabs*	*Briefing.com*	*BLS*
Apr-12	170000	116000	215000	115000
May-12	133000	124000	150000	69000
Jun-12	176000	75000	100000	80000
Total	479000	315000	465000	264000



	Original Employment Estimates - Q3 2012
	*ADP*	*TrimTabs*	*Briefing.com*	*BLS*
Jul-13	163000	115000	100000	172000
Aug-13	201000	185000	140000	103000
Sep-13	162000	210000	165000	104000
Total	526000	510000	405000	379000

The second table shows the original estimates from various sources for Q3 2012. We now know from the just announced QCEW report that all of the estimates were much too high. The overall net job growth for the quarter was only 199K – very poor. This time, the BLS was the best, but still very much too high.

Trading and Investment Conclusion

For traders, this should be a time of caution. The economic data suggest that this could be a very weak number – possibly even a negative print given the 100K error band. Readers should ignore any speculation that the Fed knew the number when meeting this week.

In my experience it has usually been safe to be conservative in front of this report. The story is so complex that it is pretty easy to generate a negative spin. Your favorite perma-bear/conspiracy site does a good job of preparing. It is poised to comment on seasonal adjustment, birth/death adjustment, labor force participation, hours worked, and discrepancies between the payroll and household surveys. Their man on the Chicago trading floor can be relied upon to convey these interpretations. He has the back of the bears, so we should all take advantage of this knowledge.

For investors, the story is a bit different. If you look broadly at all of the data, you should expect a report that is consistent with the sluggish growth we see in other reports.

For most of my accounts I am exercising caution in front of the data, and hoping for some good opportunities during the day on Friday.

A Message for “Stop” Devotees: Investing is not easy!

oldprof — 2013-04-23T22:13:52-05:00

Most people already know that investing (or trading) is not just a matter of having stop loss orders in place.

Whatever the market environment – bullish, bearish, or range-trading – there will be specific stocks that decline. In today's market, with the bogus White House bombing announcement, there were many chances for profit and loss.

The scorecard of winners and losers:

If you were trying to "protect" positions with trailing stops, you were a loser. You sold at a bad time (just as happened in the Flash Crash) and you must now decide whether or not to "chase" to re-establish your positions.
If you liked the market and had a shopping list, you might have had working buy orders. Congratulations! You are an instant winner.
If you were in on the bogus announcement, you might have been selling short in front of the news or buying when it occurred. You have cashed in, and now you must avoid prosecution. The SEC investigates some such trades, but does not do enough. There were many profiteers in 2008….still enjoying their gains.

Here at "A Dash" I have a special focus and fondness for the individual investor. Whenever your long-term positions decline, there are many who advise that you should have had "trading stops" in place. The idea is that you limit losses and let profits run. Like most maxims, it sounds great. In actual practice, we have tested trading stops in any time frame you can cite. It is not that easy!

Investment Conclusion

Rather than following a mechanical system of stops, it is far better to have a fundamental target for buying and selling. If you had that approach, you might have found some bargains today.

Weighing the Week Ahead: Interpreting Mixed Signals

oldprof — 2013-04-21T20:36:01-05:00

The daily news from financial markets is often merely a footnote to events. Last week this was truer than ever.

If you are a market professional it is your job to consider the effect of any event. The individual investor should have a different attitude.

My forecast for last week – that the market would focus on earnings – was very wrong. The "Boston effect" was obvious on Monday and had a continued presence throughout the week. This has an effect for chart watchers.

The coming week will provide more reports on earnings, as well as a time for reflection and analysis. So far, the signals have been mixed.

I have some thoughts on how to cope with this which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

This was a mixed week for news.

Inflation is tame as measured by the CPI monthly decline of 0.2% and the mild year-over-year increase of 1.5%. Former Dallas Fed President Bob McTeer debunks those who have been predicting for several years that inflation is "right around the corner." The Fed is trying to create inflation, but not succeeding. McTeer suggests that this is a reason behind the decline in gold prices. Here is his take on "money printing:"

According to the Fed's H.6 series on the money stock, M2 growth was 6.8% over the past 12 months, 5.7% (annual rate) over the past 6 months, and only 1.7% over the past 3 months. This deceleration in money growth coincides with the Fed's new round of purchases and balance sheet expansion under QE3.
Fuel price declines are helping real wages. See the fine analysis and helpful charts at The Bonddad Blog. See also the supply and demand analysis at BreakingViews by Christopher Swann and Kevin Allison. They suggest that prices might remain low even as growth improves.
Initial jobless claims were in line with expectations, confirming the return to the expected range. It appears that seasonal effects were an influence, as we noted last week.
Industrial production added a second strong month, increasing 0.4%. Instead of focusing on this indicator alone, I suggest that readers check out Doug Short's Big Four indicators followed by the NBER's official recession dating. There is a laggard, but the general picture supports continuing modest growth.

The Fed Beige Book provided evidence of continuing modest economic growth, consistent with the bulk of other economic evidence.
Housing starts show a dramatic increase of 46.7%, year over year. Single-family starts were up 28.7%. The go-to source on housing, Bill McBride of Calculated Risk, notes that the rate is still low, with another 50% year in prospect. He also explains that single family starts are the best leading indicator for the economy. This is an important article. The many economic skeptics should give this due consideration. Here is a key chart:

Prof. Shiller –drum roll – sees opportunity in housing. (Via Calculated Risk).

The Bad

The important economic news was mostly negative this week.

Chances are fading for bipartisan tax reform. (Via The Hill).
Leading Economic Indicators faded according to the Conference Board index, dropping to -0.1. Steven Hansen of Global Economic Intersection does a comprehensive job of analyzing this indicator. He is skeptical of the gyrations in a single month. See the entire article for a careful analysis of historical results, the index components, and some helpful charts. Here is a good sample:

Building Permits have been weak. Regular readers know that I take the permit data seriously. In this week's good news I highlighted Calculated Risk. The bad housing news argument is made at Business Insider. Here is a key chart:

The Revenue Beat Rate has been very poor. This earnings season has been OK on the bottom line (beating reduced estimates) but very weak on revenue. Bellwether IBM was a case in point. For many this means that the earnings cannot be sustained. For others it shows effective cost-cutting. Regardless of your interpretation, the market does not like it. Here is the summary from Bespoke:

The Ugly

Boston -- the attack and also the effort to politicize by many. The reaction of medical personnel, investigators, and the people of Boston was first-rate. At some point we can consider the long-term implications of what happened. This was part of the Sunday morning talk shows, which I always watch. There are some implications to consider, but it is too soon for me.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. Think of The Lone Ranger.

This week's award goes to Mike Konczal for breaking the story on the Rogoff and Reinhart errors. I also want to recognize the research team from U Mass – Amherst (Thomas Herndon, Michael Ash, and Robert Pollin). One of the points I tried to make at the Kauffman Conference was the need for leading financial bloggers to discover important academic findings and to explain the consequences to non-economists. Mike has done exactly that. Many others joined in with helpful posts. More on that in a future installment.

The Rogoff-Reinhart issue is not just a small error, as Mike makes clear in his excellent post. The reliance on this research finding has influenced government policy and also individual investor decisions. It takes both skill and courage to take on the prevailing wisdom.

This was a powerful story that was probably lost on many individual investors because of the dramatic events from Boston. I will revisit the theme, but the recognition is due right now. Anyone who thinks that there is a magic 90% debt to GDP trigger point should carefully read Mike's article.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

Anyone who has followed these objective indicators over the last two years has had a significant advantage in trading and investing. Each has contributed to the result. Here is how.

The St. Louis Financial Stress Index

Recession Forecasting

I feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. Dwaine also does a useful world economic review with a country-by-country analysis of the improving global recession status. Essential reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His latest update includes forecasting models for stocks, bonds, precious metals, as well as the odds on a recession. Silver now has a "buy" signal.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now eighteen months old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating --- now reflecting the most recent data. Here is Doug's latest opinion on the ECRI forecast:

Ultimately my opinion remains unchanged from my position in recent weeks: The ECRI's current position is best understood as an effort to salvage credibility in hopes that major revisions to the key economic indicators -- notably the July annual revisions to GDP -- will validate their early recession call.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level, and have now moved into the neutral range. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.

For trading accounts we are still fully invested in Felix's recommended sectors, but the choices are quite conservative. This situation is re-evaluated daily. If we no longer have three attractive sectors, we can move to bonds, to cash, or even go short via inverse ETFs.

The Week Ahead

The coming week includes plenty of news from many sources.

The "A List" includes the following:

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. Last week's stability (after two weeks of seasonal gyrations) was encouraging, but we are all watching.
New Home Sales (T). Housing activity is the best hope for continuing economic rebound.
Advance GDP for Q1 (F). This is "old news" in a sense, but perhaps it will put paid to the bogus recession forecasts. Most of us are now focused on Q2.

The "B List" includes the following:

Durable goods (W). Continuing interest as a component of GDP.
Michigan sentiment final (F). Normally I would not mention the revisions, but last month there was a big jump from the preliminary. This month there was another weak preliminary. There will be extra attention.

And most importantly of all: earnings, earnings, earnings.

Trading Time Frame

This is one of the most dramatic weeks for a trading/investing time-frame distinction. Felix has moved to a neutral posture, with ratings stabilizing around zero. There are a few solid candidates to buy, although the preferred sectors are pretty conservative. Felix is still playing the long side, but doing so via dividend stocks, consumer staples, real estate, and Japan. It is something like a bond substitute, and it is working -- -at least for the moment.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

This week reflects a sharp divergence.

The traders are mostly like Felix – one foot out the door, warning of a correction, conservative holdings, and emphasizing what has been working.

The investors have a very different approach. I wanted to highlight this week's Barron's. This is often a source of bearish commentary, but we should remain open to all viewpoints. This week's issue features their semi-annual poll of money managers and several other articles with a common theme:

Dividend stocks are overvalued.
Bonds are overvalued.
Headline fears are exaggerated.
The most attractive sectors include cyclicals, financials, and technology. Maybe some health care.
It is only the fifth or sixth inning of the recovery.

My own viewpoint is that it is the third or fourth inning. We had a fast descent and are now experiencing a slow rebound.

This is extremely difficult for the average individual investor to see. In addition to picking up a copy of Barron's this week, please read Abnormal Returns on the subject of interpreting news:

One of the reasons we investors consume the news is that we think it will provide us more information with which to make better, more profitable decisions. We think this incremental information will somehow give us an "edge." The challenge with this thinking is that more information may increase the confidence in our decisions but it does little to increase their accuracy.

This is very important for the individual investor, as is the link to Josh Brown's post on how he parses the news.

The news flow is a trap for the average investor, who is tempted to buy high and sell low.

Buying in times of fear is easy to say, but so difficult to implement. Almost everyone I talk with wants to out-guess the market. The problem? Value is more readily determined than price! Individual investors too frequently try to imitate traders, guessing whether to be "all in" or "all out."

Final Thought

Interpreting mixed data is a special challenge. This is especially true when we consider both economic and market data.

Many technical analysts see last week's data as signaling a tired market and maybe the start of the long-awaited correction. The timing of a correction –both start and finish – is difficult to forecast, as is the possible depth.

From the fundamental perspective there has been a long period of below-trend economic growth with a Fed commitment to act aggressively until things improve. This has supported a continuing growth in corporate earnings.

Scott Grannis provides this chart of returns from various investment choices:

He concludes that the "market is very worried about recession" since that is the only justification for such a wide yield disparity. This is the reason that I have highlighted important recession forecasting techniques – those that have accurately predicted the continuing expansion.

The next step will be an increase in inflation – which the Fed is actively seeking – and interest rates. This will be bad news for holders of bond mutual funds and the currently popular grandma stocks.

Weighing the Week Ahead: Time to Search for Bargains?

oldprof — 2013-04-07T15:48:42-05:00

As the market averages reach new highs, there is a sharp divergence in advice. While we digest last week's economic news and wait for earnings reports, I expect a new theme this week.

How should you react to new market highs and first-quarter trends in various sectors? Should you reduce exposure, expecting a sharp correction? Or should you shop for bargains among sectors and stocks that have lagged in performance?

As he does so often, Eddy Elfenbein provides a savvy summary of recent events and focuses on the key question:

"Let me give you the briefest summation of Wall Street over the last six months: Investors worry about something that's unlikely to happen, the financial media amplifies said worry, calming voices are ignored, the markets trends downward, the financial media then calls for civility and public-spiritedness to address the needless worry they just promoted, incredibly the world doesn't end, the worries fade away, volatility falls and the market quietly rallies.

We've repeated this dance so many times I'm beginning to lose count. There was the Fiscal Cliff, the debt ceiling (remember the $1-trillion coin), the elections in Italy, the fiasco in Cyprus and the Great Rotation out of bonds."

Eddy takes note of the recent market shift into defensive stocks and away from gold and risk. He is expecting more of the same. (His article also includes some great stock ideas).

Michael Santoli writes about the "grandma stocks" and how investors have moved into stocks that look like bonds.

There are at least three choices:

Sell in May (a topic we covered last week, Signs of another Economic Soft Patch?).
Be defensive with grandma stocks and bonds.
Look for bargains in lagging sectors.

There are advocates for each. I have some thoughts which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
It is better than expectations.

The Good

This was a generally negative week, but there were a few bright spots.

Some movement toward a budget compromise by Obama. Few understand the various inflation measures and therefore do not grasp the significance of changing to a chained-CPI method for Social Security benefit increases. The simple version is that it represents a big future cut without reducing current defined benefits. The change is hated by key Democratic groups and senior citizens. (see The Hill). Presidential second-term behavior sometimes encourages compromise. Many with a political agenda predicted a more partisan Obama after the election. It seems that the jury is still out. Here is a good account of the issue ---- from NPR!
Auto sales were good and mortgage delinquency down. Daniel Gross suggests looking at these as fundamental factors. (The data on sales were pretty much in line with expectations – "solid start to the year" via Calculated Risk).
Construction spending was up 1.2% (February data over January, seasonally adjusted). It is even better if you focus on private construction, since public construction has been a drag for four years – excellent analysis and this chart from Calculated Risk:

The Bad

The economic news was mostly negative this week.

Initial jobless claims spiked to 385,000. There could be some effects from the Good Friday holiday, since the varying date is challenging for seasonal adjustments (via Scott Grannis).
ISM Manufacturing declined to 51.3, a disappointing drop of 2.9 from February. The ISM sees this level as indicative of a 2.8% GDP, but the relationship they use seems to have overstated the GDP level recently. Another good research project for someone. Read the comments for a little more color. Scott Grannis charts the relationship and offers further analysis:

ISM Services dropped to 54.4, down 1.6 from February. Steven Hansen of GEI focuses on two important subcomponents, helping us to navigate this noisy series.
Employment is weaker – no matter how you measure it. The official BLS report of a net addition of 88K jobs was far below most estimates (although I suggested some warning signs in my monthly preview). The labor force declined by 500K workers, giving an artificial improvement to the unemployment rate. Prior months were revised higher, but that simply sharpens the monthly decline. Hours worked improved slightly, but the hourly wage did not.

It is a serious mistake to place too much weight on this report. There are several alternative methods of gauging employment. Truth emerges when you look at all of the evidence. The news reports do not have time to explain the methodology or that there is a sampling error of +/- 100K jobs. The error band in the household survey and the estimates of the labor market is over 400K (since the sample is smaller). This was a weak report that was pretty consistent with other recent employment data. There is a very good discussion of the labor force participation rate at Calculated Risk. It is time to look once again at Bill's popular chart comparing the most recent recession with those of the past. I like the version that aligns at the bottom. It is clear that we have come a long way, but much more is needed.

The Sad

We all share the loss of Roger Ebert, who finally lost his battle with cancer this week. Millions know him from his TV show and the "two thumbs up" approach. Those of us from Chicago have enjoyed the Sun Times review of this Illinois alum for many decades. Roger was passionate and outspoken. Even after he lost his speaking voice, he maintained visibility through prolific written reviews and blogging. His work will live on for many years.

Josh Brown captures the non-Chicago sentiment and provides three good links. Start with these 15 passages.

The Ugly

North Korea takes the "ugly" award again this week. Living in a world where unstable leaders have nuclear power presents special challenges. Most leaders operate with a concern for their people. For a special insight into North Korea, readers might take a few minutes to listen to this account from SnapJudgment (the fast-paced NPR storytelling show). Here is their summary:

The only father Kim Yong ever knew was the first leader of North Korea. He grew up an orphan after the Korean War and was raised to be utterly devoted to the state; blindly loyal, even. So blind that he couldn't see what was coming.

More on the policy challenge from CFR—great background!

If negotiation is challenging, the challenge for investors is even worse. I recall an old story from Art Cashin about his training during the Cuban Missile Crisis (1963). Most of the trainees thought that the crisis meant to sell. The instructor explained the error. If the leaders did not resolve the problems, it would not matter anyway….

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The St. Louis Financial Stress Index.
The key measures from our "Felix" ETF model.
An updated analysis of recession probability.

Anyone who has followed these objective indicators over the last two years has had a significant advantage in trading and investing. Each has contributed to the result. Here is how.

The St. Louis Financial Stress Index

Recession Forecasting

I feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. Dwaine Van Vuuren also has an excellent data update, demonstrating how the coincident data have reduced recession prospects. There are seven sample reports available, including Dwaine's latest country-by-country analysis of the global recession status. Good reading!

Georg Vrba is a great "quant guy" with an excellent variety of useful tools, some available via a free subscription. His take on a possible recession? Based upon unemployment data, the ECRI is wrong. His latest article questions the use of M2 as part of the ECRI's WLI.

Doug Short has excellent continuing coverage of the ECRI recession prediction, now eighteen months old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating --- now reflecting the most recent personal income data. Here is Doug's latest opinion on the ECRI forecast:

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. About a month ago we switched to a bullish position. These are one-month forecasts for the poll, but Felix has a three-week horizon. Felix's ratings stabilized at a low level. The penalty box percentage measures our confidence in the forecast. A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings. That measure remains elevated, so we have less confidence in short-term trading.

The Week Ahead

This week includes a bit of a lull in economic data.

The "A List" includes the following:

Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator. Special interest after last week's spike.
Retail Sales (F). The consumer remains central to understanding the economy.
Michigan sentiment (F). Important for both consumer behavior and a read on employment.

The "B List" includes the following:

FOMC minutes (W). A policy change is far in the future, but it is good background to monitor the Fed.
PPI (F). Inflation data will become more important when there is some sign of actual price increases.

Earnings season has the traditional kickoff with Alcoa on Monday. Some big names, including Wells Fargo and JP Morgan Chase report on Friday.

My personal week will include the Kauffman Foundation's 2013 Economic Blogger Conference. I always attend with questions in mind, and I often find answers that will benefit investors. Berkeley Prof Brad DeLong has put together a great program. Anyone can watch the live feed and send questions and comments via twitter. Last year's conference featured panelists responding to tweets from on stage as well as questions from attendees.

Please use the comments to raise the questions that you would most like to see addressed. I'll do my best to get answers.

Trading Time Frame

Felix has continued a bullish posture, but the ratings have weakened. Felix sent one of our holdings to the penalty box on Thursday. The replacement candidates had modest ratings. Since I was concerned about a weak employment report (as I described here) I called an audible and we reduced our Felix exposure to 2/3 long.

This week's Felix forecast remains bullish, but only marginally so. I would not be surprised to see a further reduction in positions this week.

Investor Time Frame

Each week I think about the market from the perspective of different participants. The right move often depends upon your time frame and risk tolerance.

Sometimes the challenge is buying the unloved stocks and sectors. It is difficult to see the opportunity when everything you read is so negative. Writers and pundits want to look smart, so they "explain" what is happening just as if they had predicted it! I will go a bit farther on this in the conclusion.

Investors who have been underinvested in stocks wonder if it is too late to invest. Those who have enjoyed the current rally are bombarded with warnings about the need to sell.

I do not see this year's current gains as a game changer for the market, and the hoopla about the new record highs is also a distraction. The early move this year mostly reflected an unwinding of fear in front of the fiscal cliff decision. I explained my rationale and emphasized the need to be flexible in adjusting your price targets in this article. The post highlights the reasoning of many analysts who have updated the market prospects rather than remaining locked into a concept created in December.

In case you missed it, please read the assessment from fellow Seeking Alpha contributor Alan Brochstein, Up 10%, Are Stocks Now too Dangerous to Hold? He touches all of the bases in his answer to the key investor question – market valuation, overheated sectors, the profit margin issue, interest rates, and even some technical analysis. There is no good way to summarize this excellent overview article, so I encourage you to read it.

But please beware! General ideas are not for everyone. Each person needs unique treatment. We have several different approaches, including one that emphasizes dividend stocks with enhanced yield from writing near-term call options – a conservative, yield-based approach.

Final Thought

One of the best ways to take the pulse of the market is by watching sector trends. I do this daily with the help of a real sector expert --- Felix, our trading model. Felix has highlighted the defensive sectors for many weeks. To illustrate I have once again opened to the public my weekly Felix column at Wall Street All Stars, where we have a vibrant community with many good ideas.

The article features iShares S&P Global Healthcare ETF -- IXJ. As I do each week I look at the featured ETF both from a trading perspective and also the viewpoint of a long-term investor. The difference is often dramatic.

As further research for today's WTWA post I checked out the top ten stocks for overall valuation using Chuck Carnevale's excellent F.A.S.T. Graphs method.

The result? The sector has a yield of 2.11% and a P/E of 16. Neither is very exciting. The individual stocks are all pretty fairly valued. Most importantly, the risk is greater than you might think. The beta versus the S&P 500 is 1.07, but something much worse could happen if and when interest rates rise.

The answer to the questions I posed in the introduction varies with your investment objective and time frame. I expect a rotation to stocks and sectors that have so far lagged in this year's rally. Traders can play the trend. For investors, it is a good time to look for bargains.