A wild week started with wonder about the extent of market
declines and ended with recovery and calm.
Opinion remains divided on what this means -- for sources,
conclusions, and strategy.
Attention is shifting to the Fed reaction.
The volatility exposed many problems in market reaction and the
ability to cash in on hedges.
China seems to be less important, suggesting many good
investments.
Dramatic events reset agendas. People re-evaluate probabilities
about what is possible as well as the personal implications.
Because the recent market story is so big and so fresh the week
will start with the punditry asking:
What are the lessons from the market turmoil?
Prior Theme Recap
In my last WTWA
I predictedthat everyone would
be asking whether the recent market decline was the start of
something big. Monday's 1000 point opening decline in the Dow
underscored the theme. The next day the story continued with a
failed rally. At that point, few would have guessed that the market
would finish in the plus column for the week.
As he does each week,
Doug Short's recapexplains this
dramatic story and his great weekly snapshot lets you see it at a
glance. With the ever-increasing effects from foreign markets, you
should also add Doug's
World Markets Weekend Updateto
your reading list.
As Doug notes, the rebound stalled at the end of the week. CNBC
quit running the "Markets in Turmoil" special report and went back
to reruns of American Greed. Attention then turned to my secondary
theme - the early reports from the Fed conclave at Jackson
Hole.
We would all like to know the direction of the market in
advance. Good luck with that! Second best is planning what to look
for and how to react. That is the purpose of considering possible
themes for the week ahead. You can try it at home.
Last week some advance planning was especially important. There
was little time to react intelligently.
This Week's Theme
Big events refocus attention and redefine the public agenda.
They change our minds about what is possible, what is likely, and
what to worry about. This week will start with more discussion
about the meaning of the market turmoil and what, if anything,
individual investors should do about it. The question for each
producer or editor in financial media will be:
What are the lessons from the market turmoil?
It is a fertile topic and worth exploring. It should keep
interest piqued until late in the week when the jobs report and Fed
implications regain center stage.
So what were the lessons?
The Viewpoints
What you "learned" from the market turmoil seems to vary based
upon your starting viewpoint. See
Josh Brown's recapof editorial
cartoonist's take on the market, including this one:
(click to enlarge)
The conclusions once again cover a wide spectrum, with
authorities lining up on all sides. Here are contrasting takes on
several different topics.
On the Overall Economic and Market Health
Steep declines revealed the inherent weakness in the economy,
stock valuations, and Fed policy. Worldwide weakness will drag
developed countries into a global recession. Central banks will
have no bullets left. The selloff and rebound provided a big
warning to the wise.
The "correction" was over. That is what we have all been
waiting for. Economic growth and the stock market rally can
resume.
We can now see how important the weakness in the Chinese
economy really is. (
Typical pieceon this theme from
Bloomberg, also running a bearish cover this week).
The Chinese threat has been examined and the effects analyzed.
The impact is limited.
The Fed can finally see the error of its ways, but really has
nowhere to turn.
The Fed is ready to move, but acknowledging some concern about
worldwide markets.
It is time to sell. Major investors who had hedges in place
last week showed significant profits while everyone else was
crushed.
The volatility did not matter if you held firm. Hedges were
difficult to cash in.
As always, I have my own ideas in today's conclusion. But first,
let us do our regular update of the last week's news and data.
Readers, especially those new to this series, will benefit from
reading the
background information.
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.
There was some good economic news, especially GDP revisions.
GDP revisions
were strong, raising the bar for expectations. The change
was so great that the "old news" had a market effect.
Scott Grannis notesthat recent
growth of 2.7% is significantly better than the former trend of
2.2%. Despite this, it is still $2.8 trillion per year below trend.
Few are thinking about the effects of a return to trend, not to
mention an overshoot.
Consumer confidence
is very strong according to the Conference Board survey.
The Michigan survey was a slight miss, but see below.
New home sales
show a solid y-o-y gain of more than 21%, despite showing
a slight miss for the month.
Calculated Riskhas the full
story, including this chart:
Sentiment on many fronts
Negative among short-term market timers (
Mark Hulberthighlights this
contrarian indicator)
(click to enlarge)
The best market timers, by contrast, are bullish. (Also from
Mark Hulbert). They have an
equity exposure 84% higher than the worst performers in Hulbert's
database.
Insider buying was at the highest level since 2011 (
Bloomberg)
The Bad
There was also some negative data last week.
Personal income and spending.
Income was OK, but spending slightly missed the
seasonally-adjusted expectations.
Steven Hansen at GEIprovides the
complete picture, with a slightly more optimistic take on
year-over-year data.
Pending home sales
showed a slight miss, while still gaining 5% on a
year-over-year basis. (
Calculated Risk).
Michigan sentiment
disappointed slightly and declined. Given the stock market
decline, those in charge of the survey thought the results held up
pretty well. This one was especially interesting because the data
represent later polling than the Conference Board report. NY Fed
President Bill Dudley noted this in answers to questions following
a speech. Fed observers seem to be watching this closely. As
always, Doug Short (and Jill Mislinski) have the
full storyincluding both
analysis and plenty of charts. It is useful to look at both the
Conference Board and Michigan surveys, which usually show a high
correlation.
(click to enlarge)
(click to enlarge)
The Ugly
The ugly award this week goes to the performance of many
financial markets. Many reasons are being offered, making this a
subject for a full post someday. For now, let us note the
following:
The "rule 48" process of opening stocks did not generate valid
prices. Customers doing market sell orders lost 20% or more on
major stocks.
ETF pricing was unfair, according to fair value based on
underlying holdings. (
ETF.com)
Options markets were extremely wide, including prices that were
"below parity" and therefore impossibly unfair.
Popular hedging products like the VIX did not even have quotes
until the market had regained more than 50% of the early losses.
(Options expert
Adam Warner)
Some online trading sites were not responding.
Systems overheated, creating a "glitch." (
Reuters)
The products and rules have become more complicated. This has
permitted more products and increased revenue for the exchanges. It
may not have improved opportunities or fairness for individual
investors.
Quite frankly, the best thing that the individual investor could
do during the turmoil was beware, and maybe stand back. Buy orders
were OK, but that was not the mission of most traders on Monday
morning.
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, for separate articles on a theme, to
Michael Batnickand
Todd Sullivan(citing "Davidson).
Both illustrate the danger in the way the Shiller CAPE ratio is
presented to investors. Batnick notes:
When Shiller says 15-16 is where CAPE has typically been, what
he really means is this is what the
averagehas been. However, what he fails to mention is that
over the past 25 years, the CAPE ratio has been above its
historical average 95% of the time. Stocks have been below their
historical average just 16 out of the last 309 months. Since that
time, the total return on the S&P 500 is over 925%.
Sullivan shows that the profit estimates in the data are flawed
because of accounting changes. He shows that large and completely
implausible changes in "earnings" were actually the result of the
FAS 157 rules.
Noteworthy
As a professor I made it a point to review and update
illustrations and references in pop culture, but it was a
swiftly-moving target.
Beloit College providesa "mindset" list
highlighting the experience of incoming freshmen. If you are forty
or older, I guarantee that this will make you feel even older. The
list has 50 entries. A few of my favorites?
Incoming students have always had Google.
They have never licked a postage stamp.
They have grown up treating Wi-Fi as an entitlement.
The announcement of someone being the "first woman" to hold a
position has only impressed their parents.
Whether a trader or an investor, you need to understand risk. I
monitor many quantitative reports and highlight the best methods in
this weekly update. For more information on each source,
check here.
Recent Expert Commentary on Recession Odds and Market Trends
Bob Dieli does a
monthly update(subscription required) after the
employment report and also a monthly overview analysis. He follows
many concurrent indicators to supplement our featured "C
Score."
Georg Vrba: An array of interesting systems.
Check out his site for the full story. We especially like his
unemployment rate recession
indicator, confirming that there is no recession signal. He
gets a similar result from the
Business Cycle Indicator. Georg
continues to develop new tools for market analysis and timing,
including a
combination of models to do gradual
shiftingto and from the S&P 500.
Doug Short: Provides an array of
important economic updates including the best charts around. One of
these is monitoring the ECRI's business cycle analysis. Jill
Mislinski has joined Doug's team and provides
this week's update.
RecessionAlert: A variety of strong
quantitative indicators for both economic and market analysis.
While we feature the recession analysis, Dwaine also has a number
of interesting systems. These include approaches helpful in both
economic and market timing. He has been very accurate in helping
people to stay on the right side of the market.
Dwaine has a new signal from his Stock Market Health Diffusion
Index, something he calls a
high alert. At the moment, it is
just an alert, but it bears watching. (We note the similarity to
Felix's conclusion this week).
It is very big week for economic data.
The "A List" includes the following:
Employment report (F). Most important remaining data before the
September FOMC decision.
ISM index (T). Private data with both concurrent and leading
qualities.
ADP employment (W). A good independent read on the changes in
private sector jobs.
Auto sales . Surge is a sign of consumer strength. Pickup
trucks indicate construction strength.
Construction spending . July data, but an important
sector.
ISM services (Th). Gets less attention than the manufacturing
survey, but actually covers more of the economy.
Initial jobless claims (Th). The best concurrent news on
employment trends, with emphasis on job losses.
The "B List" includes the following:
Beige book . Anecdotal data used in the Fed decision process.
This sometimes gets a lot of attention.
Chicago PMI (M). Most important of the regional surveys.
Trade balance (Th). July data of special relevance for Q3 GDP
and evaluating effects of dollar strength.
Factory orders . July data and a volatile series.
Crude oil inventories . Current interest in energy keeps this
on the list of items to watch.
While the Jackson Hole conference is over, there is plenty of
FedSpeak on tap. Expect wide-ranging opinions.
How to Use the Weekly Data Updates
In the WTWA series I try to share what I am thinking as I
prepare for the coming week. I write each post as if I were
speaking directly to one of my clients. Each client is different,
so I have five different programs ranging from very conservative
bond ladders to very aggressive trading programs. It is not a "one
size fits all" approach.
To get the maximum benefit from my updates you need to have a
self-assessment of your objectives. Are you most interested in
preserving wealth? Or like most of us, do you still need to create
wealth? How much risk is right for your temperament and
circumstances?
My weekly insights often suggest a different course of action
depending upon your objectives and time frames. They also
accurately describe what I am doing in the programs I manage.
Insight for Traders
Felix has switched to "neutral," but is almost completely out of
the market. The confidence in this three-week forecast remains
extremely low with nearly all sectors in the penalty box. Felix
withdraws from the market when volatility gets very high. It is
simply not a good environment for the model. I noted reports that
many system-oriented trading firms have temporarily suspended
trading. There is nothing wrong with waiting for better conditions.
The inverse funds, bonds, and gold recently moved up the rankings,
but are mostly in the penalty box. For more information, I have
posted a further description --
Meet Felix and Oscar
. You can sign up for Felix's weekly ratings updates via email
to etf at newarc dot com. Felix appears almost every day at Scutify
(follow him
here).
See this week's "Ugly" section for more on trading
challenges.
I review the themes here each week and refresh when needed. For
investors, as we would expect, the key ideas may stay on the list
longer than the updates for traders. Major market declines occur
after business cycle peaks, sparked by severely declining earnings.
Our methods are focused on limiting this risk. Start with our
Tips for Individual Investorsand
follow the links.
We also have a page summarizing many of the
current investor fears. If you read something
scary, this is a good place to do some fact checking.
O
ther Advice
Here is our collection of great investor advice for this
week.
If I had to pick a single most important article, it would be
this
article from Morgan Housel,
explaining the results and challenges for individual investors.
First, the results.
(click to enlarge)
Please read the entire post. A key theme is that investors blame
performance on the wrong things - the market cheated them, etc.,
when it is mostly their own poor market timing.
Energy --Back in Focus
On several occasions I have explained why "energy" should
not all be traded like an oil futures contract.
Joshua Kennondoes a very good
job on this topic, backed up with data and charts. A key point is
that the oil majors must operate on a longer time frame than the
quarterly report. You acquire reserves when it is possible to do
so, not when compelled, for example. It is a long post, but well
worth reading. Here is a key point, familiar to regular WTWA
readers:
For the oil majors (as opposed to the pure plays, which are a
different story), that's not the whole picture. It is entirely
possible for a trader or hedge fund manager to say oil stocks are
overpriced at the moment, calling for them to decline
anda long-term investor to say that oil stocks are
undervalued at the moment, preaching you should use your funds to
load up on them. That seems almost nonsensical; a paradox.
Nevertheless, it's true when you understand one fundamental fact:
When you buy a share of the oil majors outright, paying for it in
cash and locking it away,
you are being paid to absorb volatility over multi-year
periods.
For this reason we frequently have one of the big integrated oil
companies as part of our Enhanced Yield portfolio, capturing both
dividends and income from selling calls, with the expectance of
gradual long-term growth.
Commodity guru
Jim Rogers sees a
potential rebound.
Dividend strategies
. Please read this
excellent comprehensive guide.
Is it enough to cash your regular payments, ignoring the stock
price? Or should you focus on total return? Rob Martorana's
absolutely first-rate article is written for the community of
investment advisors, but it is not a secret. Individual investors
will appreciate the advice.
Personal Finance
Professional investors and traders have been making Abnormal
Returns a daily stop for over ten years. The average investor
should make time (even if not able to read every day as I do) for a
weekly trip on Wednesday. Tadas always has first-rate links for
investors in this
special edition. As always,
there are several great links, but I especially liked this
article from Monevatoron the
need for a plan. Does this sound familiar?
When markets fall, some panic and consider selling. That's
natural.
Others act brave, rub their hands, and boast about it being
time to buy- to be greedy when
others are fearful.
That sentiment is right, and they can sound like bold
geniuses.
But how long were they sat in cash, waiting for the moment to
get back in?
If you buy equities when they drop 10% but you missed the
previous 50% rally, you're not being greedy when others are
fearful.
Not in the bigger picture.
You're actually being timid when others are stoically betting on
the long-term propensity of stock markets to
rise over the long-term.
And you're probably going to be left poorer compared to someone
who is less cunning but more pragmatic.
The price they pay for their long-term gains is not feeling as
smug as you when the market does swoon. They have to take their
lumps.
As I suggested last week, we have the key news from Jackson Hole
in time for WTWA, but not in time for Friday's trading. Fed
Vice-Chair Stanley Fischer granted a CNBC interview on Friday which
seemed to cover many of the key points from his Saturday keynote
speech. The speech was a little hawkish, but I do not expect a
major market reaction to this on Monday.
Sam Ro at Business Insiderhas
good coverage along with key charts from the speech.
Here are some key takeaways:
As of a few weeks ago, the Fed was probably ready to act in
September;
The Fed rates economic strength significantly higher than do
the various financial markets;
Market volatility is not the determining factor in a delay, but
it is a consideration;
The Fed sees the current low levels of inflation as a "one off"
effect of lower energy prices and dollar strength;
The Fed will not wait until after there is more inflation
before starting the process of withdrawing accommodation; and
finally
The process of normalizing rates will be gradual - perhaps very
gradual.
And of course, Fed expert
Tim Duy's take. And finally, a
member-by-member scorecard (
Steve Goldstein).
With so much attention on China, U.S. investors need to
understand the implications for their portfolio. Everyone is trying
to figure out which sources are reliable and how serious slowing
growth is for the rest of the world.
Sound?Or
not sound? Dueling professors
look at different data. It is all interesting. And keep in mind,
from a Nobel Prize Winner, that
the Chinese stock market does not give a good read on the
economy.
At the peak of concern last week I provided a summary of
What Investors Must Know about China
. China expert Nicholas Lardy reached similar conclusions in a
NYT op-ed piecepublished the
same day.
The
New York Times is
highlighting"zombie factories" with a dramatic slide show. In
sharp contrast,
Templeton's Mark Mobius, perhaps
the most respected source on international investing sees jammed
malls and expensive purchases. (Mobius's frequent flyer miles make
the
George Clooney characterseem like a piker!)
Mobius provides some investing ideas along with this interesting
thought:
A lot of attention has been given to slowing gross domestic
product (NYSE:
GDP) growth in China. It bears
repeating-China's growth rate may be slowing, but one of the things
that gets lost in translation is that while the percentage
increases in the economy are indeed slowing down, but the actual
dollar amounts are going up. When China's economy was growing at
10% in 2010, about US$844 billion was added to the economy, but
with growth at 7.7% in 2013, US$986 billion was added.
2
I would also emphasize that 7% growth is nothing to sneeze at,
either, given the size of China's economy. It should not be a shock
to see growth slow.
Long-short equity funds, which have now lagged for more than a
decade. (
Eqira).
The past week was a great test for many investors. If you were
prepared and had confidence in your plan, all was well. If you were
calling audibles, you were likely to go wrong.
My own take on the lessons?
The China concern is over-rated, both because the economy is not
as bad as advertised and because the US does not compete so much on
exports. I expect companies that benefit from cheaper Chinese goods
to show better profits.
The energy market is showing a little strength. The benefits of
lower prices will start to show up for some companies, and the
eventual market price will be OK for suppliers. There are
opportunities here.
The Fed is more accurate on the economic prospects than the
financial punditry. It is much better than the commodities market,
which has (once again) dramatically over-estimated the probability
of a recession. Falling oil prices have
neverpredicted an economic downturn. (
GaveKal).
The market timers who "predicted" the selling may not have done
as well as advertised. Think about the following (all examples I
read in major media):
Some of them have been waiting for this for many months, paying
put premiums throughout
Claims of profits on Monday were not "locked in" gains, but on
paper. Much of this was gone by Friday. (
Example).
Many of the big bears saw Monday and Tuesday as verification of
their theories about the market being 50% over-valued. They were
not selling their puts. They were waiting for more or rolling
positions.
Those who tried to cash in struggled because of illiquidity or
unfair pricing in markets.
If you think it is wise to have protection in place, this week's
experience helps to see how difficult it can be to manage your
hedges.
Those who read and considered this section last week may have
escaped without major losses, and maybe with some gains in the
market turmoil. I hope so.
Let me turn to this week's investment thought.
Investment Conclusion
I still do not know whether we have a real near-term market
bottom in place. (Neither does anyone else). I was right about
retail panic last week.
I continue to see the trader/investor difference as crucial. I
expect continued economic strength in the U.S. and improvement in
Europe. While watching China and energy closely, the focus on
commodity prices as an economic indicator is mistaken. I expect the
Fed to start raising rates. It will have little impact on most
sectors, but will help financials.
As a result, I find good opportunities, as follows:
Financials, especially regional banks, from rising rates
Technology, since skepticism about the dollar is overdone
Energy, since the dollar will not grow at the same pace, the
economy is better than expected, and geopolitical risks are showing
up
Health care - especially stocks with little or no China
exposure
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