A Dash of Insight

Bias in Bernanke Coverage: Does it Matter?

2009-12-04T21:28:40-06:00

There is a lot of biased news coverage these days. Some of it its intentional, and some of it is not.

Today's example is the coverage of the Bernanke reappointment hearings.

The Reality

From the perspective of those whose opinion matters, this is a foregone conclusion. Chairman Bernanke showed real leadership when it was most required. Under his guidance, the Fed took many creative steps to avoid an economic collapse.

If one looks to objective sources from both parties, the conclusion seems obvious. Bernanke was appointed by President Bush and reappointed by President Obama. His support is broad-based and extensive among professional economists. He will be confirmed.

As is often the case these days Bob McTeer has the strongest analysis. He provides a good case for the Bernanke reappointment. Anyone wanting a reality check should watch the video here and read the article here. Since I know that many readers will not click through to the links (although they should) the following captures the gist:

What I don’t understand is why politicians think their deviant behavior is so appealing back home. They apparently don’t have a very high regard for the home folks, especially those in Kentucky and Vermont. My guess is that those folks are better than their Senators give them credit for. Surely blue grass and autumn leaves have some calming effect.
To my way of thinking, Chairman Bernanke (and Secretary Paulson) deserve the highest praise for saving our financial system and avoiding another great depression. I’ve defended Bernanke in blogs, speeches and TV appearances (see previous post). So have wise people like Warren Buffett. But our way of thinking, apparently, is not making any headway.
I heard yesterday that a major poll showed a majority against Bernanke’s reappointment. I guess that shows the power of financial TV and its guests who compete with each other in outrageousness hoping to be invited back.

We got to watch Congress in action. Hearings provide a platform for those with eccentric views to spout off and get publicity. Even the most lightweight of Senators gets to have his moment in the sun.

The practical result? Some Senators have made an issue of the reappointment, placing a "hold" on it. This means that there will be a real vote, not approval by voice vote. It is quite possible that the vote for approval will be lower than in past instances, as noted in this WSJ article.

The Fiction

Internet readers got a totally different picture. At Seeking Alpha, where I am a contributor, the big story was the "Bruising of Bernanke." (I want to make it clear that Seeking Alpha tries to present a balanced view of stories. Most likely the articles showing some balance did not come through in time to provide this balance. Mea culpa -- I could have written about this yesterday, but other duties impinged. The editors react to the flow of stories. Perhaps they will square it up a bit in the future.)

But let us look at the result of the Bernanke bashers, including the writers of the featured stories and a few others.

When you get criticism of an appointment, it is news, but we need to look at the sources and the biases. For investors, I recommend looking beyond the salacious stories and focusing on what is really going to happen. The attack stories get headlines, similar to the media frenzy about Tiger Woods. It is good for page views, but not really helpful in understanding the reality. The critics include the following:

Those running for office. Some commentators have a clear political agenda. They think that it would have been a wonderful cleansing experience if the Fed were not to have fought the onset of a depression. It will be interesting to see how this platform plays in front of the electorate.

Those who have a book to push. Some pundits lay all of our troubles on past Fed mistakes. Everything they write is colored by support for this viewpoint. While their followers accept the premise, the verdict of history will be rendered by those with a more objective stance.

Those who have a blog based upon attacking the Fed. Most of these arguments include rather simplistic and often inaccurate accounts of the Greenspan Fed, now extending to the Bernanke Fed. There is little effort to distinguish between the actual tools available, and what was needed when confronted with the collapse of Lehman.

Those citing public opinion. This is very interesting. The public can name the Three Stooges, but not the three branches of government. Any time an issue is technical, we expect true leaders to look beyond polls. Many of those citing public opinion take the other side of the argument when politicians react to polls. They call it "pandering." In fact, most officials make some careful distinctions.

The amateur political scientists. This includes the commentator who has no known experience in actually making public policy decisions who declared Bernanke to be "politically naive." He is swinging out of his "happy zone" as the Splendid Splinter called it.

And others with a hobby horse. This includes the "live blogging" on Bernanke at TheStreet.com's Real Money site (usually helpful when focusing on stocks) where some commentators thought that their own personal viewpoints about public policy should be accepted by all. The assertion that Bernanke was telling lies was particularly offensive. One should never substitute personal opinion for fact. The Bernanke testimony is available to all -- subject to objective analysis.

A Credibility Test

When I read those commenting on economics, I employ a simple test which I recommend for readers. I call it the "Chalk Test." Economic analysis can be controversial. The "big minds" can and do differ, but they share certain basic skills. If you gave them a piece of chalk and asked them to do a simple problem -- a supply and demand curve, and analyze the effect of an excise tax -- they could all do it. Most of the popular blog writers cannot pass this test. They write about economics, but they do not know the basic skills. Their real skill is in dishing out pop concepts to a group of readers who already agree with their conclusions.

This is dangerous for the average investor -- very dangerous.

Investment Conclusion

The bashers of the Fed have been wrong for a long time. Essentially, they argued that the Fed was in a box, and would be ineffective in staving off a depression. They were wrong.

Instead of recognizing the error, they now want to vote out the leadership and change policy to suit their own viewpoint. They are wrong again, since this will not happen in the case of Bernanke.

Since the Internet audience is not a representative sample (think about the Dewey defeats Truman headline, where the polls had an unrepresentative sample), the flow of stories, augmented by thumbs up, thumbs down, conveys a false impression to the average investor/reader.

Most of the same sources now suggest that the Fed will soon make many other mistakes (beyond my current scope, but more later).

Repeating an important recurring theme at "A Dash", I suggest that investors should be politically agnostic. It is better to make money regardless of who is in power, than to lose money, or miss opportunity, while complaining about politics.

Employment Report Preview

2009-12-02T21:31:26-06:00

The market has the regular monthly focus on the employment situation report. An hour before Friday's opening the data will be announced. It will be sliced and diced by various experts. Assorted pundits will be poised to offer comments via email to those in the MSM blogs or anchors on CNBC.

The report has so many different aspects that it is the happy hunting ground for spinners. For many months it has proved right to be cautious, if only because the bearish spinners seem to get the attention. We have traded the report from that perspective. Even when the number was better than expected, it is usually possible to trade out with a modest loss.

Job Creation

One reason for the loss of confidence is the breakdown in the Bureau of Labor Statistics (BLS) model for the birth/death adjustment. We described this in some detail last month. Since then we have actual data from state employment reports.

Here is the information from the latest Business Dynamics Report.

There are two key things to note:

There is still plenty of job creation. This always occurs, even in a recession, but it is usually ignored by analysts. Gross job gains were 4.6 million in Q109 at existing establishments and over 1.1 million at new establishments.
The difference in job creation and job losses weakened in the post-Lehman era and plummeted in Q109.

This dramatic decline was the cause of the breakdown in the birth/death adjustment. Readers should note that the BLS estimate still needed to add job creation. This is in dramatic contrast to the many critics who remain skeptical than any new jobs are formed, despite the actual data count.

The problem is that estimation methods that had worked well for many years, including the turning point at the start if the recession, broke down early this year. The credit crunch had an effect on new business formation, something greater than in the last recession, as the chart shows.

Employment Report Background

We have urged that market observers should view the BLS report as one of several measures of changes in employment, not as the "official" result. The BLS method attempts to count every job in the economy in one month, count it again in the next month, and report the difference. Using this method, the BLS has no choice but to make an estimate about job creation. Later, they benchmark against known data.

We explained this carefully last month, but it bears repeating:

Each of the sources we cite is attempting to measure the actual net job change. A wise stat prof once said, "Suppose God whispered into your ear and told you the TRUTH."

The BLS is attempting to do the same thing, with dramatically different methods. The BLS result is not TRUTH. It is a statistical estimate. Actual TRUTH for a specific month will not be known for many months, when the state employment data are analyzed. The BLS tries to count all of the jobs in one month, all of the jobs in the next month, and then report the difference. They do this very well, but it is inherently difficult. It does not focus direclty on the actual changes, as other methods attempt to do.

Meanwhile, the forecasters will all be graded by how well they predicted the BLS number -- the BLS estimate of TRUTH.

That is the wrong attitude. The BLS number is just another estimate -- and one which will not be official until all of the revisions are in. Despite this, the market will trade on the preliminary estimate revealed Friday morning.

Our Approach

Each month we ask the question, "What change in payroll employment would be consistent with other economic data from the same time period (the middle of the prior month)?

This is not a forecast, per se, since we do not posit any causal relationship among these variables. They are all concomitant indicators of economic activity.

We use the four-week moving average of initial unemployment claims, culminating in the week of the employment survey. This is the best direct indicator of new lob losses. This has improved in the last three months to a loss of 513K. Note that the most recent dramatic decline to 466K is not within the survey period.

We look at the University of Michigan sentiment survey, which we found more useful than the Conference Board's sentiment index. Michigan uses a panel, where some families are carried over from month to month. This is a good technique. Sentiment is influenced by employment. When people have lost jobs, or are worried about losing jobs, it shows up in sentiment. It is a good concurrent indicator. The Michigan index is now at 67.4, down significantly from the last two months.

We us the ISM manufacturing index, which declined to 53.6 from 55.7 This is still quite bullish for the overall economy, but the downtick is bothersome.

Our long-term record has been pretty good, especially when compared to the final revised data. This makes sense because our model was derived from the final data. In recent months we have been too bearish. The BLS benchmark revisions suggest that we have been much better than first thought.

Our estimate is for a net job loss of 175,000.

Other Forecasts

It is always interesting to compare the job forecasts from different sources. We follow several because of the interesting and widely varying methods they use. A wise interpretation would be to consider all of these disparate sources of information.

ADP has proprietary data because of its payroll management business. ADP sees losses of 169K.

TrimTabs also uses real time data. Their estimates are based upon tax deposits for salaried employees. They see a net job loss of 255K.

WANTED Technologies, a relatively new entrant in this field, has a model based upon online help-wanted advertising. This is an innovative and different approach to real-time data. They see a net job loss of 155k.

Briefing.com cites the consensus as a loss of 125K and their own forecast is a loss of 150K.

All of these sources are valuable. The 90% confidence interval on the BLS estimate, something that no mainstream media sources report, is +/- 100K or so. And that is after revisions and benchmarking. It is a survey -- a good one -- but it has an error band.

Investment Conclusion

Businesses reduced employment dramatically and swiftly last autumn. Job creation has lagged. Employment is an important indicator for politics and for the average citizen. It continues to be a lagging indicator for investors.

Investors are Reaching -- and Making Big Mistakes

2009-12-01T22:05:25-06:00

Has anyone else noticed the rise of dubious investment propositions?

I am getting quite a few inquiries from clients and others about some great opportunities they have been offered.

I am seeing more email than usual about "home run" stocks and systems.

Both print and television adds have a focus on gold. Please note that we frequently have positions in gold ETF's, but some of the advertising recommends gold strategies where investor might overpay for illiquid assets, and also pay a big commission.

There are systems that seem to offer a guaranteed yield far above prevailing rates, without much ability to gauge the underlying value.

These are only examples.

I am working on a series covering this theme. I invite readers, including colleagues in the advisory business, to send me additional examples.

More to come....

[long GDX and XME]

Health Care Legislation: Our Prognosis

2009-12-01T21:49:30-06:00

There is an interesting development in the health care debate. Action by the opponents of health care reform may actually be counter-productive to their avowed interests.

Background

From my perspective, trying to help investors, the analysis of health care legislation has not been very good. Most analysts were slow to grasp the fact that many committees had some power. Eventually there was recognition that the bottleneck might be in the Senate, and everyone focused on the 60 votes needed for a cloture motion -- cutting off a filibuster.

The Wall Street firms and the media alike have really cut back on staffing, so there are few genuine experts in political science who are working on this problem. This makes it an opportunity for investors with some real insight.

Recent Developments

Last week the Senate passed the 60-vote hurdle on Majority Leader Reid's plan. That will now be the subject of a full debate.

Does it mean that there are enough votes for the plan? No.

Does it mean that the public option will be included? No.

One of the best sources of insight into the process comes from Nebraska Senator Ben Nelson, who is not in favor of the overall legislation, but nonetheless voted with the majority to move to a full debate. Sen. Nelson wrote an op-ed piece in the Omaha World-Herald last week, explaining his vote for last week's motion. There is a very nice analysis of the article on our sister site, ElectionStocks. (I set the agenda for this work and always review the output. Investors who want to know how policy-making may affect their investments should add the site to their readers. There is plenty of information about policy initiatives and which stocks could be winners and losers.)

Some Predictions

Regular readers of "A Dash" understand that we do not advocate particular policy positions. We have opinions, of course, but that is not our mission. We aim to enlighten readers about the stock implications from what is likely to happen.

With that in mind, here are some of my own fearless forecasts:)

Some health reform legislation will pass this year. There is a lot at stake for the President and the Congress. Delay simply means defeat. They will do whatever it takes.
The legislation will meet the test of the "minimal winning coalition" which we described here. It will be a compromise, with whatever inducements are necessary to get the needed votes.
Most pundits will hate the compromise. That is the nature of policy-making in a pluralistic society. This is not recognized by the Wall Street analysts or Internet pundits. Many have a political agenda, so there comments will relate to their interpretation of the merits, not the likely outcome. Others view the wheeling and dealing that is essential to legislative action as some defect in representative government. They need to take a class; it is covered in Poli Sci 101. If you don't like it, find your favorite dictatorship. It is how legislatures work in representative democracies.

The Twist

Here is the interesting part for political observers. The Senate debate will attempt to gain a 60-vote majority, to avoid a filibuster. Some liberals insist on the public option. Some marginal voters want a trigger mechanism. Others are adamant in opposing the public option since they see it as the start of a government takeover of health care.

If these opponents all hold firm, the most likely outcome at this point, the 60-vote requirement will not be met.

In this case, the Democrats might try to pass legislation through the reconciliation process, a budget procedure intended to facilitate tax cuts and spending cuts that otherwise could not get the 60-vote margin. Sen. Reid has publicly disavowed this strategy, but the Nelson article makes clear the existence of this latent threat.

Health care legislation through reconciliation would be stripped of many specific provisions, but a public option would probably be included. Why? This may pass the test of a budget-cutting measure. Other provisions would fail on a parliamentary challenge.

The Result

To understand the likely result, one has to have the reconciliation "twist" in mind. It is possible that some marginal voters will realize that they can have more leverage over the final bill by avoiding the reconciliation alternative.

We are going to see a few weeks of debate that will determine the final shape of the bill.

Stock Implications

So far in the process, many health care stocks have remained undervalued because of uncertainty. Typically, they rally when chances for passage seem dim.

Our analysis is that there may be a dip as the market senses the likelihood of passage. Then, whatever the specific outcome, there will be a rally in many of these stocks when the uncertainty is lifted.

We will go shopping in the health group, with specific sub-sectors and names in mind.

ETF Update: Trading Discipline in a Time of Turmoil

2009-11-30T00:11:36-06:00

When there is news that seems to be dramatic, it creates a stressful environment for traders and investors alike Everyone should analyze the fundamentals of the situation, as we did on Friday.

It is also helpful to have a system. Understanding your own method is the key. It requires a level of system development and testing where you have real confidence. Our own method is not geared to turning points in the market, but it reacts pretty quickly to key changes.

Background

In our disciplined system, we study sectors continually, looking at the charts and ratings for hundreds of ETF's. Each week we provide a list of our top-rated sectors for the next three weeks, along with some of our current observations. ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation. Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF system. (For new readers, there is a more complete description of our methods at the end of the article. We also have a free report with more detail on the system and results, available on request.)

The model also provides a nice feel for the overall potential of the market. I'll take a look at the macro picture first, and then take a look at our featured sector of the week.

The Macro View

From an overall market viewpoint, our indicators have improved. The key elements are as follows:

80% of our ETF's in positive territory ( up from 55% last week). The median strength rating for the overall list is a plus 18 (up significantly from +1 last week). A score of "0" implies the average long-term ETF expectancy.
Only 27% (down from 97%) of our sectors are in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons. You can think of this as a sophisticated "stop loss" rule, often applied in advance. See our article here for a further explanation of this method. We implemented some faster filters this week, accelerating moves both into and out of the Penalty Box.
Our index package is positive. For this rating we look at the ETF's (both long and short) for the S&P 500, the Dow, and the Nasdaq. You can see these ratings is the results table for this week.

Spotlight on Dubai

It was a week of turmoil. Occasionally breaking news seems more important than trading fundamentals. This is especially true in a holiday week, where thin, half-day trading exaggerates the impact.

Looking at Fundamentals

There are many different ways of interpreting the news depending upon one's method and time frame. There were plenty of instant experts on Dubai. At Abnormal Returns, the go-to source when you want viewpoints on a current issues, you can find the expected arguments. These range from those who foresee a massive sell off to those who view the problem as "contained." (Someone needs to find a synonym for that word in a real hurry!)

Abnormal Returns serves up the best arguments from all sides, and then it is up to you. That is fine for a certain audience, which includes those looking for assurance that their current position is correct. Many readers need more, including some interpretation of the conflicting analysis. David Merkel wrote a thoughtful analysis and also included some good links. His conclusion is mixed.

Jim Bianco, writing at The Big Picture, emphasizes the importance of the timing of this issue. His nice article includes capsule summaries of many mainstream media pieces.

My own Friday piece may be useful for those trying to interpret the news. I attempted to highlight the actual analysis and how to interpret the actual trading by following the dollar. If you are not really an expert on Dubai, why pretend? It is better to evaluate the arguments and issues.

In my own review, I was troubled by several prominent bearish arguments:

The market reaction showed the inherent fragility. In fact, the market reaction was little more than normal volatility, especially in thin trading.
The dollar would have a flight-to-quality, leading to major stock selling. Actually, the dollar spiked at the opening and sold off rather quickly. The dollar lost ground to the Yen, but DXY is still in the range from the past week.
The dollar carry trade is about to unwind, and the market could crash. I am really trying to pin down how the cross-currency carry trade relates to US equities. There is a generalized claim about "printing money", borrowing at zero percent, and buying "risk assets" which are deemed to include stocks. I am still looking for the specific mechanism for borrowing at zero percent and buying stocks. I invite reader enlightenment on the specifics. (I wrote about the correlation, but there are many conflicting reasons for that.)
Most of those advancing these arguments have been looking for such signals for many months. There is a natural "reach" for any evidence.

On the other side, there seem to be many reasons to view this problem as a matter for lenders and backers, in an amount that is small compared to their assets. A solid analysis of other areas that are real-estate dependent would be most welcome.

Looking to Your System

An important check on one's fundamental analysis comes from actual trading. Our TCA-ETF system helps us in this way.

By looking at actual trading -- not just the immediate reaction, but data over a few sessions -- one can learn the market verdict. There is an important lesson:

Even if you are correct in your fundamental assessment, the market may disagree.

In such cases it may be better to live to fight another day. Meanwhile, our method smooths out the trading blips from a day or two. It remains bullish, and we will watch to see if the verdict changes.

Weekly TCA-ETF Rankings

We got back into the market this week, and the timing was not good. The S&P was about even while we lost some ground (two percent), especially since foreign markets did not catch up on Friday. We expect more accurate marks on our foreign ETF's on Monday.

We provide these ratings as information for readers who may not trade as frequently as we do. Those signing up for our free weekly email update can also get the entire list.

As noted above, the macro market indicators are in the penalty box, and most other ETF's are in the penalty box. Based upon the current model signals, we have moved to a bullish posture in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 280 ETF's. The list also includes the values for the broad market ETF's and their inverses. While the list is, as usual, from the prior day's close (Wednesday), the Friday output is not dramatically different.

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation. Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method. In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike. While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks. The fundamentals may be more difficult to assess. Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's. This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves. Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF. While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box." The basic elements are used by many, and widely reported. We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model. We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

Reacting to News: What to Make of Dubai?

2009-11-28T00:19:41-06:00

Here at "A Dash" we try to identify the best experts on any subject. Since we are free to position our clients in any way, we are consumers of news and analysis. So are you.

While I manage client portfolios in real time, my writing is after hours. I am not trying to advise people with short-term trading horizons. Our TCA-ETF approach (still bullish) has a three-week time horizon. Our program for long-term investors has an even longer time frame.

When I write, it is an honest assessment of my own views and an attempt to find the real authorities. It is not trading or investment advice. It is just something you might want to consider.

The Issue

Each night I get the daily report from Charles Kirk, a valuable service for his subscribers. Charles (who is currently neutral on the market in all time frames) always includes a quotation with his analysis, and today's is especially apt:

"Look at market fluctuations as your
friend rather than your enemy; profit
from folly rather than participate in it."
- Warren Buffett

This is a great statement of the issue. Is the Dubai reaction the start of something bigger, or an opportunity to "buy a dip?"

The Analytical Viewpoint

At TheStreet.com's Real Money site (subscription required) Marc Chandler, a source for whom we have great respect, wrote as follows:

We stress again that the current troubles being seen in Dubai are a direct result of its efforts to tie its fortunes to global real estate, tourism and services, and are particularly unique to Dubai and should not have wider implications for sovereign EM risk. The property boom helped this strategy work in the good times, but the popping of the global real estate market has put severe strains on Dubai.
Developments in Dubai should thus be seen in the context of the entire country basically being geared toward real estate development and not in the context of EM sovereign risk and fundamentals. Thus, while the current period of risk-off trading could yet persist, longer-term investors should be looking for buying opportunities in EM during this correction.

We note the careful analysis of the nature of the problem, and how it might be connected to various markets.

The World Leadership Viewpoint

Other sources also provided perspective on this issue.

Banks, world leaders play down Dubai debt threat, from Reuters. The article quotes leaders from the US, Britain, France and Japan.

The Bearish Viewpoint

Those who have been calling for a market correction see this as the start of something big.

Pimco, with a bearish viewpoint on stocks and now even seeking less risk in bonds, calls it the start of an "overdue correction."

Others, whom we will not name, see this as the first step in the decline of commercial real estate. Or they say that we should not believe anyone who sees this as "contained" because someone or other said that subprime would be "contained."

The Trading Viewpoint

Barry Ritholtz, despite a continuing bearish tone from most articles, expected a rebound from the overnight bottom and was pretty accurate with his pre-opening call.

Our Take

There is a widespread acceptance that any warning of doom is correct, and every event is proof. If so, the case against buying stocks is clear. There will always be something to worry about.

Today's bears did not make a very good case.

I watched the currency trading closely. The dollar flight to quality ended rather quickly. The trade-weighted dollar is about where it has been for the last week. And I am still waiting for someone to show a good link between low treasury rates and the ability to speculate on US stocks.

There were plenty of buys in individual stocks that have nothing to do with Dubai, European banks with big exposure, or even the dollar carry trade.

I don't know if Warren Buffett was buying today, but I was.

ETF Update: Mid-Week Bullish Changes

2009-11-23T22:22:06-06:00

Each week we provide a ranking of ETF's. We show our macro perspective as well as highlighting specific sectors of interest. We do this based upon closing data from Thursday, with a complete record of our positions and trading from the prior week.

Mid-week trading is part of our business. We run our model twice daily and adjust positions as indicated for individual accounts -- our customers.

For this reason, we do not advertise our ratings as a "trading signal." It is intended as news information, something that the ETF investor can consider as part of his/her own decision process.

Occasionally, something happens that is pretty dramatic. When it occurs very quickly after my weekly update, I feel uncomfortable about the message from my regular weekend article.

Today we saw a major change in our ratings, with many sectors emerging from our penalty box. With the market highly correlated to the dollar, this is not a big surprise. Many technically-based methods trigger with breakouts when there are new highs.

Summary

Our posture changed dramatically today with a number of new buys. These include several of the top ETF's in our list, escaping the penalty box. We hinted that this might happen, but in addition to RYH, we bought GDX, QQQQ, and some other highly ranked sectors. We are now fully invested.

Once again for emphasis, I am not promising to do a mid-week update any time there is a change in the model. In this case, it seemed especially important to share the change with loyal readers.

ETF Update: Health Care Legislation and Health Stocks

2009-11-22T21:49:22-06:00

"What's the news?" is the first question when we see a big move in a stock or sector. There is always some reason, valid or not. Knowing the news explanation is an important step for those who trade on fundamentals.

After months on the national stage, the debate over health care reform has reached the final act. In the next few weeks we will know whether national policy will change, and the nature of that change. Meanwhile, the health stocks have been signaling "There's news" on a regular basis.

Let us first take a look at our approach to spotting emerging sectors.

Background

The model also provides a nice feel for the overall potential of the market. I'll take a look at the macro picture first, and then take a look at our featured sector of the week.

The Macro View

From an overall market viewpoint, our indicators have improved. The key elements are as follows:

55% of our ETF's in positive territory ( up from 31% last week). The median strength rating for the overall list is a plus 1 (up slightly from -6 last week). A score of "0" implies the average long-term ETF expectancy.
97% (up from 93%) of our sectors are in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons. You can think of this as a sophisticated "stop loss" rule, often applied in advance. See our article here for a further explanation of this method.
Our index package is neutral, but leaning positive. For this rating we look at the ETF's (both long and short) for the S&P 500, the Dow, and the Nasdaq. You can see these ratings is the results table for this week.

Spotlighting Health Care

Our ETF universe has several health care choices, but the fastest-moving is the Rydex S&P Equal Weight Health Care ETF (RYH). ETF expert Tom Lydon notes that, as opposed to other health care ETF's, RYH emphasizes small and mid-cap holdings. RYH has a diverse holding including 52 stocks. The P/E is 20.4 and the price-to-book is over 3. The beta is currently 1.0, but we expect it to move higher as the health care legislation progresses.

Health care stocks have responded mostly to the market, but partly to the twists and turns of health care legislation. Here is the chart for RYH. The charts for other choices -- IHF and IYH -- are similar.

This is a key situation. We would not be surprised to see the sector pop out of our "penalty box" for a purchase this week. This may depend upon the health care legislation.

A Look at the Fundamentals

Health care stocks have operated under a cloud because of the ongoing debate over reform legislation. Analyzing public policy and the impact on stocks is our sweet spot, so this could be a special opportunity in the weeks to come. Here is what you need to know and where to look for more information.

The Basics. Major legislation is a process of coalition-building. The result is a compromise program that no one really loves. It goes with the territory in a representative democracy. We expect our representatives to angle for legislation that reflects the needs of their districts.

This concept -- the formation of a minimal winning coalition -- is well-established political theory. Interested readers should check out William H. Riker's seminal work from 1962. There is a long political science literature on the theory of the minimal winning coalition. To build a majority, the coalition adds provisions that attract the marginal voter. That voter, honestly and wisely representing his/her district, bargains for provisions in the new law.

I understand that opponents of health legislation are calling this bribery. This is as old as the hills. You can find legislative examples from many countries and many eras -- all showing the same thing. To decry this form of coalition-building is the functional equivalent of condemning representative government. It merely means that the critic does not like the outcome, and therefore criticizes the process -- usually without any constructive alternative. It is not partisan, since all parties have used this approach.

The Implementation. I strongly recommend that investors put aside their opinions about the policy and focus on what stocks will benefit.

Where to Look. Our sister site, ElectionStocks.com, has extensive coverage of the health reform legislation and the potential stock impact. We expect a resolution of the health issue to help the entire sector. The market hates uncertainty, and this will be lifted. The health group may well emerge from our "penalty box."

Weekly TCA-ETF Rankings

We were mostly out of the market this week. The S&P lost a little ground and we did also on small positions.

We provide these ratings as information for readers who may not trade as frequently as we do. Those signing up for our free weekly email update can also get the entire list.

As noted above, the macro market indicators are in the penalty box, and most other ETF's are in the penalty box. Based upon the current model signals, we have continued our neutral position in the Ticker Sense Blogger Sentiment poll, despite the slight positive edge in the ratings.

Here are the top sectors from our expanded universe of 280 ETF's. The list also includes the values for the broad market ETF's and their inverses.

Note for New Readers

A Profitable Pattern

2009-11-20T22:13:02-06:00

I have noticed a profitable pattern. I am going to cast this from the bearish perspective, but in theory it could work either way. I have a few other historical examples, but let us focus on the present.

Background

Investors have many time frames, and so do those managing money. When you see someone interviewed on CNBC it could be a mutual fund manager, a hedge fund manager, or a trader. It is natural for everyone to talk his book, but the time frame is relevant.

A mutual fund manager likes to see holding increase, get publicity, and attract new assets. Having said this, these managers are not likely to sell into rallies. Instead, new money in their funds gets invested at current prices in current holdings.

A hedge fund manager or trader is different. Their disclosures warn that they may change opinions and trades in a heartbeat. They can, and should, do so. A five percent move in a stock is a major trading profit.

The Process

A portion of the hedge fund community takes a position. For this example, it is a short in semiconductor stocks. The position is supported with plenty of reasoning they deem to be rigorous and also by technical analysis. It is especially desirable to find a situation where a sector has made a big run. A chart of the SOX tells the story.

I haven't added any lines in this, and readers should ignore the last decline, since that is the end of the story. The point is that analysts could have a field day with this chart -- before the decline.

Cocking the Hammer

Those establishing a bearish position wish to highlight major concerns. In this case the "hammer" was the question of double booking of orders. This occurs when inventories are so low that those building mother boards want to be assured of needed parts. To do this, the theory holds, they place multiple orders for needed parts in short supply, canceling some orders when their needs are met.

It is an argument that raises a question about the validity of reported orders, and creates fear that the orders will decline.

Pulling the Trigger

One might think that actual evidence of order decline would be necessary to trigger the fear. That assumption is incorrect. It is easy to grasp any news as evidence that this prophecy has been fulfilled.

Yesterday the B of A/Merrill analyst downgraded the entire sector. The resulting report, which I have read carefully, is based upon an inventory model and some assumptions about where we are in the cycle. It does not specifically refer to any double booking, and the resulting forecasts are still above many other Street observers. It was a big call, getting a lot of play, and knocking down the stocks by 5 percent or so, as the chart indicates.

Bearish observers incorrectly cited the double booking argument, not actually mentioned in the report. It talks about a small "overshoot" in inventories, not mentioning any double booking. It is based upon a theoretical model, without a lot of supporting evidence. Since few actually read these reports, the inaccurate summaries gain credence.

The Result

Anyone with a short position can cover for a nice trade. It was a nice setup. Any downgrade could be cited as evidence. When the analyst from a big firm downgrades, everyone pays respect, at least in the short term. That is long enough for traders and hedge fund types.

The Facts

There is plenty of evidence contradicting the double-counting argument:

From iSupplyCorp we have the following:

In their earnings announcements, leading semiconductor suppliers, including Texas Instruments, STMicroelectronics and Intersil, all reported they saw no signs of double-booking during the third quarter, said Ciriello. “This should give the semiconductor industry confidence that the magnitude of the current recovery accurately reflects real demand levels.”

A balanced article at the WSJ mentions the double-booking issue:

Another analyst, FBR Capital's Craig Berger, also cited signs of weakening PC demand, though he said in a note, "We do not want to get overly bearish on the PC space given improving global demand and still-unknown holiday sell-through trends."
Berger said he remains "bullish" on the semiconductor sector. "We think fears of a first half of 2010 estimate cuts from double ordering are overblown, that global supply chain inventories are at or near all-time lows, that global demand trends will continue to recover in 2010."

Astute tech stock observer Bob Faulkner writes as follows (see the full article for his nice inventory charts and complete analysis):

I've tracked inventory in the electronics-supply chain for years. While it’s too early in earnings season to draw any final conclusions, I think it’s very safe to say that inventory is quite tight on a relative basis.

Steve Ballmer reports that Microsoft sees "fantastic sales" for Windows 7. If this is accurate, it should stimulate a new cycle of purchases. More people and businesses replace computers -- especially those who avoided VISTA -- than upgrade existing machines. The current hardware may not be adequate and is difficult to configure.

Our Take

The trading setup is a real dilemma for managers with a long-run horizon. It was completely predictable that something -- anything -- would be seized upon as confirmation for the double-booking argument. There was no need to wait for actual evidence. Even knowing this, should the manager blow out all of his chip holdings, expecting a pull back of unknown size?

The real answer for those with a longer perspective is to focus on the actual time frame and ignore the bumps in the road. The traders will make their profits, and eventually the results will tell the story. It is an opportunity to add to positions for those who disagree with the thesis.

An Interesting Exercise

There was a similar setup -- hammer pulled back -- on car sales after the Cash for Clunkers expired. Perhaps this is a good topic for an example where we now have more evidence -- an immediate decline, followed by a restoration in sales.

I invite other examples -- both long and short -- from readers. Look for the setup -- what we all should watch for-- and then look for evidence.

Our position: Long INTC, MSFT, and AAPL.

Specific Expertise: Insisting on the Best Information

2009-11-17T21:55:09-06:00

Here at "A Dash" we have emphasized that we are all consumers. We are consumers of data, of analysis, and of opinion. Our principal mission is helping readers understand their role as consumers and figure out what sources and information to follow.

Background

Here are two widely-accepted findings to consider. Both have strong support from empirical evidence on market returns.

Stock analyst ratings often lag, so the wise contrarian investor fades the consensus opinion.
Chasing performance is a major source of losses. Those who "called the last move" are often the mean-reverting cases. One needs to look at long-term performance.

These precepts are widely accepted in the investing community. (I will add that both are part of my own approach to stock-picking, with a nice long-term return.)

Meredith Whitney

Yesterday afternoon CNBC indicated that Meredith Whitney would be featured on Maria Bartiromo's program. Regular readers know that we are big fans of Maria. We think that she asks the right questions and draws out interesting answers from high-profile guests. Many market participants guessed at the nature of the interview and sold the market before and during her interview.

You can check out the key points of the Whitney interview here.

Our Take

Meredith Whitney, in her prior role as bank analyst with Oppenheimer, did one thing well --- very well. She accurately predicted that banks would need to write down assets. She accurately predicted that there would be no FAS 157 relief on mark-to-market accounting, so there would be a death spiral of bank value declines. Those following her predictions made significant profits and/or avoided losses.

Since starting her own firm, Whitney has expanded her universe of predictions. She is now making forecasts about the economy, the housing market, and consumer behavior. (I regularly read her work via my helpful Oppenheimer rep when she worked there, but now I get the information along with everyone else).

It is quite fair to question Whitney's skill at economic forecasting. Her success related to analyzing bank holdings, not forecasting the economy. Personally, I prefer a different approach to economic forecasting, and so should you.

Her current bearishness is grounded in valuation -- financial stocks should return to tangible book value. When asked what would make her bullish, she responded in valuation terms, giving the example of BAC at 3. She does not believe that banks have sound core earnings, despite an attractive yield curve.

Others have commented on Whitney's bearishness, with varying conclusions. Quite frankly, most of them use the wrong criterion. They talk about how well she has predicted the market -- either last year, or this year, or both. This is a very small universe for inference, dependent on a couple of key conclusions in each case. The circumstance this year, including marking assets to market, are quite different from last year. Whether or not one agrees with government policy, the various arms of our Federal government are all on a concerted mission.

A More General Conclusion

We are all bombarded each day with fresh opinions about our investments. These are now taking the form of the CEO interview. I modestly suggest the following guidelines:

CEO's are great at discussing their current business;
CEO's are sometimes helpful in discussing what is in their pipeline (analyze this skeptically and carefully);
CEO's have no added advantage when offering opinions about the future of the economy, beyond what they see in their own business. They are reading and analyzing the same news that we are.

Readers might enjoy revisiting our Ted Williams strike zone article --- emphasizing the importance of staying in your "happy zone."

[I am long GS in personal and client accounts and hold a small BAC position as well. I am slightly long in trading accounts and remain fully invested in long-term accounts.]