Weighing the Week Ahead: Will the Fed Hint at a NewCourse?

March 21, 2019by Jeff Miller

of NewArc Investments, Inc.With a light economic calendar including a lot of old data and an FOMC meeting, the choice of focus for pundits is obvious.Investors might well wonder what new information about the Fed might be available, but that won’t stop the speculation.Pundits will be asking:

Will the Fed hint at a new course?

Last Week Recap

In last week’s installment of WTWA I took on a very ambitious question: Would a slowing Chinese economy lead to globalrecession. Since you could write a book or two on this topic, I acknowledged that it was much too big for a WTWA theme.So why bring it up? I am dedicated to highlight an important issue each week. It was the facile explanation in a decliningmarket but got less attention during a week of rallying. The punditry seemed confused about market strength in the face oftheir perception of weak global data.

The financial news once again focused on the sensational stories.

The Story in One Chart

I always start my personal review of the week by looking at a great chart. This week I am featuring Investing.com. Inaddition to several choices of index, they include versions for both cash and futures. The interactive charts are very flexibleand highlight key news events.

Stocks gained 2.9% on the week, only slightly smaller than the 3% trading range in a week that was mostly straight up.You can see volatility comparisons in our Quant Corner.

Personal NotePage 1, © 2020 Advisor Perspectives, Inc. All rights reserved.

I plan to take a week off, but it will probably include both of the next two weekends. Mrs. OldProf is not going, but she hasapproved and encouraged this. I’ll pipe up if something important happens, and I’ll try to do an indicator update as well.

Noteworthy

An important aspect of investing – perhaps the most important – is a forward-thinking approach. Too many are focused onhistory and obvious current problems. This prevents them from finding the best long-term investments. Starting byidentifying and understanding fundamental changes helps us find future winners. Artificial intelligence is such a theme.Consider the following facts from techjury:

By 2025, the global AI market is expected to be almost $60 billion; in 2016 it was $1.4 billionGlobal GDP will grow by $15.7 trillion by 2030 thanks to AIAI can increase business producitivity by 40%AI startups grew 14 times over the last two decadesInvestment in AI startups grew 6 times since 2000Already 77% of the devices we use feature one form of AI or anotherCyborg technology will help us overcme physical and cognitive impairmentsGoogle analysts believe that next year, 2020, robots will be smart enough to mimic complex human behaviorlike jokes and flirting

Techjury’s research on artificial intelligence is summarized in this post. It is packed full of data, including a wonderful (andhuge) infographic. Read the entire article to see which companies and countries are leading in AI development along withmany other interesting facts. Here is a small section of the infographic.

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The News

Each week I break down events into good and bad. For our purposes, “good” has two components. The news must bemarket friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should,too!

When relevant, I include expectations (E) and the prior reading (P).

New Deal Democrat’s high frequency indicators are an important part of our regular research. Long-term indicators arenow neutral and the nowcast is slightly positive. He expects further deceleration this year.

The Good

Retail sales for January increased 0.2% beating expectations of a -0.1% decline and December’s prior of -1.6%(downwardly revised from -1.2%). The ex-auto result was even stronger, a gain of 0.9%. We are still behind on thisseries, so February data normally available by now will be released on 4/1. The March data will be delayed only bytwo days and is now scheduled for 4/18. Everyone is still pondering the December decline that did not correspond toother retail reports.Michigan Consumer Sentiment registered 97.8, beating expectations of 94.9 and P of 93.8. Jill Mislinski’s greatchart puts the result into perspective.

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Inflation reports remained mild. CPI increased only 0.2%, as expected and only 0.1% on the core. PPI headline wasup 0.1%, beating expectations of 0.2%. The prior (Feb) was revised from +0.1% to -0.1%. This affects subsequentmonths.Durable goods orders for January increased 0.4% beating expectations of a -0.6% decline. The December resultwas a gain of 1.2%. February data will be released about a week late on 4/2. The March data is on schedule.Construction spending for January increased 1.3% beating expectations of 0.3% and much better than December’sdecline of -0.8%. February data will be released on 4/1, back on schedule.Small business optimism increased in February. (Calculated Risk). As the chart indicates, this sentiment is downfrom recent highs but still at historically strong levels.

The JOLTS report for January continued strength in the openings to unemployed ratio as well as the Beveridgecurve. David Templeton (HORAN) has analysis including this chart.

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The Bad

New home sales Calculated Risk notes

With these revisions, sales increased 2.3% in 2018 compared to 2017. I expect sales to be around the samelevel in 2019 as in 2018 (not fall off a cliff), and my guess is we haven’t seen the peak of this cycle yet.

Industrial production increased 0.1% in February, much better than January’s (upwardly revised) decline of -0.4%but missing expectations of a 0.4% increase.Brexit votes reject all current plans, producing confusion. The conventional wisdom is that markets hate uncertainty.Avi Gilburt provides some insight, explaining the dangers of interpreting daily news as if it were Newtonian physics.Gasoline prices rose 4.7% last week, adding to the prior week’s 3.1%. The average price in the US was $2.55,which is still thirteen cents better than one year ago. (EIA via GEI)Rail traffic falls further reports Steven Hansen (GEI), focusing on the rolling average of the “economically intuitivesectors.” He notes that the American Association of Railroads traffic data shows no year-over-year change. Thisreport includes several interesting ways to look more deeply into the data.LA area port traffic declined in February on a year-over-year basis. (Calculated Risk). It was also lower on a rolling12-month basis, comparing February to January.

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The Ugly

The New Zealand attack and all of the media and social media that encourage such action. The effects may beunintentional, but the actions are driven more by profit than public interest.

The college admissions scandal was the early leader this week but is now a distant second. In this case the losers arenever specifically known.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to lookfor and how to react.

The Calendar

The calendar is light, and we are still catching up on old data from the shutdown. Some will be interested in the leadingindicators for February. The Philly Fed index is for March. Many are interested in this and it sometimes moves markets inthe short term, but I don’t find it very helpful.

The big event is the FOMC rate decision and accompanying press conference.

And of course, stay tuned for anything new on the DC soap opera, which so far has had little market effect.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

The calendar – light and including a lot of old news – invites publishers and pundits to emphasize fluff stories. The oneevent of substance is the FOMC meeting, announcement, and press conference. Fed watchers are hoping for more insightthan they got on last week’s 60 minutes interview. Looking deeply into the statement and Chairman Powell’s explanations,pundits will be asking:

Will the Fed signal – or even hint – at a possible change in course?

The Current Viewpoints

Very few expect the Fed announcement to change interest rates at this meeting. The varying viewpoints all relate to futurepolicy.

1. The first camp believes that the economy is very weak, much worse than the Fed thinks, and that the likely nextmove is a cut in rates, probably in January. These observers also claim that the Fed should have raised rates earlierso that they would have more room to cut now.

2. The second camp sees the economy as stronger and is concerned about a tightening labor market. While wage gainsare good for workers, it is a signal for higher inflation expectations. If the Fed starts worrying about expectations, rateincreases will become more likely. The Fed seems to view higher rates as necessary for normalizing policy but isexercising caution. Given the lag in monetary policy effects, there is always the risk of waiting too long.

3. A third camp –a very small one – sees the Fed as doing pretty well. Decisions driven by data could well avoid theconcerns of the first two groups. It is also possible that the Fed economists have a better grip on what is going onthan does the trading community.

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A second matter that will be closely watched is guidance on the unwinding of the balance sheet. The Fed has beennonchalant on this point, mostly because they expect it to have little effect. The investment community’s simplistic take onQE implies an opposite reaction to balance sheet reduction. James Bullard, President and CEO of the St. Louis Fed,explains why this is wrong. Here is his summary:

I will now turn to the case for relatively small macroeconomic effects of balance sheet reduction. My argument hasthree parts:

1. A baseline neutrality theory suggests that temporarily increasing the Fed’s balance sheet size beyondthe minimal level needed to implement monetary policy has no macroeconomic effect at all when thepolicy rate is well above the zero lower bound.

2. When the policy rate was near zero, the Fed’s balance sheet policy nevertheless had an importantmacroeconomic impact through a signaling channel. In particular, bond purchases signaled “lower forlonger” for the policy rate.

3. With the policy rate now well above zero, this signaling channel is no longer operative, and the baselineneutrality theory again applies.

What are the policy implications of this theory? My argument suggests that it is indeed possible to view QE as havingan important influence on the macroeconomy and simultaneously view the macroeconomic effects of reducing thebalance sheet as relatively minor.

This important post goes to the heart of the difference in the Fed viewpoint. My biggest criticism of the Fed iscommunication, even in the age of transparency. If they did something as simple as to hire a couple of interns to readfinancial blogs and watch Rick Santelli, they would have a better sense of market perceptions.

What should you do when confronted with a concern that doesn’t really make sense? If you can assuage it without cost,you have an answer. That was the reasoning behind Powell’s famous “pivot,” and I hope it has an impact again next week.We should all be watching for Fed guru Tim Duy’s preview.

While the Fed meeting will occupy the financial community, there will be little lasting effect. I have something moreimportant to consider in today’s Final Thought.

Quant Corner and Risk Analysis

I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. Imonitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.

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Short-term and long-term technical conditions continue at the most favorable level. Our fundamental indicators haveremained bullish throughout the December decline and rebound.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools. The unemployment rate does not signal a recession, nordoes the business cycle index. Here is Georg’s most recent update, No Sight of Next Recession: Business Cycle IndexUpdate.

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Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. With recent data onimportant indicators, it is time for an update of the Big Four, those most important for recession dating.

The story remains strong across the board, but the two pink spots in December and January are troublesome.

Guest Commentary

New Deal Democrat, with more of his long-leading indicators available, confirms his Q4 recession watch. He explains thisas follows:

…(T)reat this in a similar way to a “Hurricane Watch”, as if the 5-day forecast cone for the hurricane included yourarea. There is an enhanced chance of the event occurring, but not a sure thing unless the conditions continue – inthis case, the long leading indicators do not quickly reverse, and the short-term leading indicators turn negative for asustained period of time.

Davidson (via Todd Sullivan) disagrees writing Recession Talk is Mythology. Read the full post for charts and data, buthere is the key point:

The best investment opportunities occur when market psychology leans far from the economic facts. The currentperiod is one of these. Recession fear still dominates the media while economic trends in place since the beginningsof the current cycle in 2009 continue to trudge higher.

David Templeton (HORAN) describes the consequence: Investors Have Missed Out on the Equity Rally. Here is one of hischarts.

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Insight for Traders

Check out our weekly “Stock Exchange.” We combine links to important posts about trading, themes of current interest,and ideas from our trading models. Last weekwe asked whether market momentum had returned. This is an importantcomponent of many trading systems, including several of ours. Our trading models are back in action, so we discussedsome recent picks. Felix rates the top twenty NASDAQ 100 stocks and Oscar does the same for the most liquid ETFs.Pulling this altogether was our regular editor, Blue Harbinger.

Insight for Investors

Investors should embrace volatility. They should join my delight in a well-documented list of worries. As the worries(shutdown, Fed policy, trade) are addressed or even resolved, the investor who looks beyond the obvious can collecthandsomely.

Best of the Week

If I had to recommend a single, must-read article for this week, it would be Michael Batnick’s Twenty Craziest InvestingFacts Ever. You will find many surprises and plenty to ponder in this list. I especially liked these:

1. Since 1916, the Dow has made new all-time highs less than 5% of all days, but over that time it’s up 25,568%.95% of the time you’re underwater. The less you look the better off you’ll be.

9. U.S. one-month treasury bills went 68 years with a negative real return.What’s safe in the short-run can be risky in the long-run.

17. Warren Buffett is the greatest investor of all-time. In the 20 months leading up to the dotcom peak, BerkshireHathaway lost 45% of its value. The NASDAQ 100 gained 225% over the same time.

An important theme is excessive focus on short-term performance which is longer than you think and worrying constantlyabout what Mr. Market thinks your portfolio is worth. The two comments on gold tell another great story.

Stock Ideas

Chuck Carnevale continues his first-rate sector-by-sector analysis of candidates for further research. This week he looks atthe Health Services Sector, a very interesting group to consider. Here are the candidates. Get a great lesson in stock

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analysis and then do your own work as well.

Energy stocks are featured in this week’s issue of Barron’s. There are many ideas for those seeking to add positions in thissector.

Barron’s also has an interesting piece on solar stocks. Check it out to see growth forecasts and some specific ideas.

Andrew Hecht explains how seasonal activity in gasoline portends good news for refiners. While volatile, he finds Valero(VLO) attractive. In this post he explains how to use the futures curve in your stock analysis.

How about Dollar General (DG)? Valuentum likes it based upon fundamental business trends but does not find the sharesto be cheap. D.M. Martins Research, which holds the stock in its all-weather portfolio, is concerned about margincontraction. Since Holmes, one of our trading models, bought the dip last week, this should be an interesting stock tofollow.

How about defense stocks? Morningstar takes a close look at the defense budget request identifying the implications forspecific contractors. Watch out for those that face cuts. Barron’s also identifies some winners.

Is insider buying a tipoff for choosing a stock at a new low? Barron’s considers CVS.

Personal Finance

Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Eachweek he highlights stories of interest for both advisors and investors. His consistent creativity highlights new angles andfamiliar problems. This week I especially appreciated his thoughtful question, Does It Matter How You Stack UpFinancially? Examining a new online tool for comparing yourself via Federal Reserve data, highlighted by Squared AwayBlog, he takes note of the risks involved in using it.

Read the entire post to see Gil’s argument. And I bet you can’t resist trying out the tool!

Watch out for…

Buying the dip in Boeing. Fallout from the Boeing 737 MAX 8 Crash Could Last for Yearssays Barron’s. The article includes a look at the order backlog and the likely cash-flow effects, even if the grounding is only6-8 weeks.

Mortgage-backed securities. Jim Grant, who has returned to write a column for Barron’s. He explains some of the risks,highlighting AGNC. What can happen when your debt to equity ratio is 9-1?

Get-rich-quick gambles. I received an email notice offering a $25,000,000 NCAA bracket prize. The problem? You had topick all 63 games right. This has been done as a freebie in past years, but these guys want a $25 entry.

Final Thought

Everyone knows about recency bias, a key aspect of behavioral economics. I can remember when investors, shocked by1987 or 2001 or 2008 markets changed their plans forever. Knowing that the bias exists does not help to avoid it, even forexperts.

Suppose you are a value investor, embracing the method that has worked best over a long span of history. You probablyhave not kept pace with recent market moves, since the general market reflects fear (a rush to bonds, utilities and dividendnames) and the FAANG group. Value investors know that eventually the risks and rewards reflect reality, but this does nothelp in the short term.

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The key question is whether you really want an ETF that is loaded with over-valued big names, utilities, and “dividend”stocks. Alternatively, you could avoid the over-priced stocks and shop for those with an earnings growth rate stronger thanthe PE ratio. The move in the cheap semiconductor sector last week illustrates how this works.

For those who share my interest in buying low, here are some great sources. I have chosen them because they provideinformation I want.

Seeking Alpha, and especially Chuck Carnevale. My past posts reveal my take on the best sources.The new site, FATRADER, which has assembled an excellent group of fundamental analysts. I am happy to be partof this and have been doing some posts there. It is also a place where you can easily get expert opinion on yourideas. Of course, you could always call one of those guys advertised on TV…..Those I follow on Twitter. I spend a little time examining ideas each day and retweeting the best of them. Some windup in WTWA. If you follow me on Twitter (@dashofinsight) you will see my retweets and my public lists.And last but certainly not least is Event Shares. You can register for free and get some terrifc information aboutpending public policy decisions and stock effects. The managers are so close to my own approach that I reached outto them for a conversation. I am doing work with them and also invested in the ETF. This is an example of what youcan see at no charge.

I hope these ideas prove helpful while I take a little time off. And remember the key points for success:

Look ahead for trends, avoid over-valued stocks, and pay less attention to the opinions of Mr. Market.

I’m more worried about:Brexit, where the EU countries may not unanimously agree to an extension, especially without a hint of what might bein the offing. 20% of British jobs are at risk. (The Conversation via GEI).US/China trade matters. The public understanding of this issue remains very poor.

I’m less worried aboutThe Fed balance sheet unwind.Recession concerns, especially as we move past Q1 data and get some stability.

© NewArc Investments, Inc.

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