Weighing The Week Ahead: The Return Of Volatility
Jeff Miller | Feb 04, 2018 03:50AM ET
The economic calendar is light. That leaves plenty of time for the pontificating punditry to opine on a possible turning point in markets, bubbles and overheating, the Fed, geopolitical risks, and continuing Washington turmoil. Many will be asking:
What does the increased volatility mean for financial markets?
In theDoug Short design with Jill Mislinski updates and commentary. You can see many important features in a single look. She notes the new records along with other indicators. The entire post is well worth reading for the collection of charts and analytical observations.
The decline for the week also reflected a larger trading range and included intra-day moves that exceeded those of recent months. Volatility has returned.
A key question is how long the current decline might last, and how large it could be. As a starting point, this history of drawdowns over the last ten years is quite helpful.
Drawdowns of 5-10% are completely routine, often occurring several times a year. The last two years have been quite unusual.
h3 Personal Note/h3Our weekend away was enjoyable and successful. While Mrs. OldProf and I did not win the event, our team came in second in a strong field. Thanks to our well-wishers.
And a special thanks to Focus Economics for including us in the list of top blogs in economics and finance . There is a wide variety of great sources, including some that you probably have not seen.
h3 The News/h3Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
The economic news remains very positive, despite the reaction of the markets this week. New Deal Democrat’s weekly comprehensive indicator update should satisfy even the nerdiest observer. I read it every week. Here is his conclusion:
Get The News You Want
Read market moving news with a personalized feed of stocks you care about.Get The AppThe near term forecast remains extremely positive. The downturn in stocks took them back to where they were 3 weeks ago, and so is not a major concern. The nowcast also remains positive.
The Good
- Construction spending was up 0.7% beating expectations of 0.3%.
- Earnings news remains positive. As usual there have been some blowups in big names and conflicting reaction to comments in conference calls. These draw the attention in financial media. Halfway through this season, the data paint a brighter picture. John Butters (Brian Gilmartin takes this an important step further, describing the impact on expected earnings, now 18% for 2018.
- ISM manufacturing had a slight decline from December’s high, but beat expectations with a reading of 59.1 (Bespoke ).
- Personal income growth increased from 0.3% to 0.4%, beating some estimates.
- Ford truck sales were “monster” according to Bespoke . This is a good proxy for small business and construction activity, they argue.
- Consumer confidence moved even higher, from 123.1 to 125.4. (Michigan sentiment of 95.7 declined slightly from December’s 95.9, but beat expectations.
- Factory orders were up 1.7% beating expectations of 1.3%.
- Employment news was positive.
- ADP reported private employment net gains of 234K, much higher than the expected 190K.
- Initial jobless claims declined to 230K, a bit better than expectations of 238K.
- Nonfarm payrolls increased by a net of 200K jobs, beating expectations of 180K.
- Private payroll gains were up 196K, also beating expectations, consistent with ADP.
- Unemployment remained at 4.1%, but the number of long-term unemployed (over 27 weeks) declined from 22.9% to 21.5%.
- Hourly earnings were up 0.3%, in line with consensus, and December’s reading was revised from 0.3 to 0.4%. The year-over-year increase is 2.9%.
But… Hours worked declined from 34.5 to 34.3, missing expectations. Many translate this into an adjustment to job gains. There was also a 24K downward revision in payroll jobs from the prior two months. Dr. Robert Dieli’s excellent monthly employment analysis takes a comprehensive, close look at the data. It is unusual to find a first-rate economist who also writes well and knows how to present data effectively. Bob’s conclusion was that the story is not quite as good as it appears on the surface. He notes the decline in the rate of growth in net job gains. His analysis is not alarmist because it is placed in the context of his overall business cycle updates.
The Wall Street Journal always has an excellent chart pack on the employment numbers. Here are two of my favorites, each illustrating a key point in the report.
- ADP reported private employment net gains of 234K, much higher than the expected 190K.
The Bad
- Productivity declined 0.1% in Q417, from a gain of 2.7% in Q3. This contributed to a unit labor cost increase of 2.0%, Q/Q.
- DC shenanigans threaten. The posturing is difficult to read as various deadlines impend. I usually expect 11th hour compromises after all sides have demonstrated their commitment. Their backers expect this. It seems like there is more “digging in” than usual.
- GDP increased only 2.6% in Q4. This story is a week old, but worth mentioning. Eddy Elfenbein notes the result and looks deeper into the data.
- Excessive exuberance among the might in Davos? Fortune’s excellent CEO Daily analyzes the sources of excitement. Others wondered whether this was a contrary signal.
The Ugly
This week there is a choice. A Cleveland man, shot sixteen times , could not get an ambulance since he was over a city boundary. This is simple, factual, and possibly illustrative of intergovernmental problems and issues in the health care system.
The second choice is both more speculative and more significant.
old character . The spies were focused on the U.S. financial infrastructure.
Possible change in nuclear policy. The most recent nuclear policy review encourages smaller weapons and permits their use even in situations where there has not been a nuclear attack. The stated purpose is deterrence of non-nuclear threats, including cyber-attacks. This is an important story which we should all follow.
The Doomsday Clock now shows only 2 minutes to midnight . This is in no way related to the items cited above! This is tied (with H-bomb development in 1953) for the shortest time in history.
As is usually the case with “ugly” news, there is no good way for investors to hedge.
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 look for and how to react.
The Calendar
We have a light economic calendar. The ISM Services report is a good coincident read on the economy, and perhaps some leading qualities on employment. The JOLTs report is helpful for the study of labor market structure and the economic cycle but is rarely used or reported accurately.
In the wake of last week’s FOMC meeting, the quiet period has ended and FedSpeak resumes. The most important news will once again be corporate earnings reports, especially discussions of outlook.
Briefing.com has a good U.S. economic calendar for the week (and many other good features which I monitor each day). Here are the main U.S. releases.
Next Week’s Theme
The light economic calendar is insignificant compared to the market reaction and the continuing focus on Washington. In normal times, corporate earnings would take center stage. Instead, the increase in stock (and bond) volatility will have everyone asking:
What does the spike in volatility mean for financial markets?
As usual, here is a typical range of opinion, from bearish to bullish.
- The crash is starting – read anything from the usual suspects.
- The major correction is upon us – read those who have been forecasting a correction almost weekly for five years. (See the solid, witty and entertaining commentary from Alan Steel ).
- The much-needed and healthy selling is upon us. (A solid viewpoint, well stated by Horan Capital Advisors ).
- Higher wage gains will move the Fed to raise rates four times instead of three. (how the Fed views inflation ).
- Caution is indicated. (Schwab ).
- 700 points is a small move in percentage terms. “Trivial so far” said one respected observer.
- Economic fundamentals and earnings remain strong.
As usual, I’ll suggest my own interpretations in today’s Final Thought.
Quant Corner
We follow some regular featured sources and the best other quant news from the week.
Risk Analysis
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.
The Indicator Snapshot
We use several different tests for technical health. The signals are bullish in all time frames.
The Featured Sources:
Bob Dieli : Business cycle analysis via the “C Score.
RecessionAlert : Strong quantitative indicators for both economic and market analysis.
Brian Gilmartin : All things earnings, for the overall market as well as many individual companies.
Georg Vrba : Business cycle indicator and market timing tools. None of Georg’s indicators signal recession.
Big Four .
Guests:
Scott Grannis notes that rising bond yields are a positive for stocks.
Prof. James Hamilton updates his GDP-based recession indicator – better and more sophisticated than the two-down quarters rule of thumb. His findings remain consistent with our regularly-cited sources.
Insight for Traders
Our discussion of trading ideas has moved to the weekly Stock Exchange post. The coverage is bigger and better than ever. We combine links to trading articles, topical themes, and ideas from our trading models. Blue Harbinger has taken the lead role on this post, using information both from me and from the models. He is doing a great job, presenting a wealth of new ideas and information each week.
As he often does, Dr. Brett provides insight for both traders and investors. His post on preventing emotional trading is helpful to everyone.
He also has done an excellent organization of information on his long-running blog. (There’s a good idea for many of us!) This makes it easy for anyone to check out the best resources from his past work.
Insight for Investors
Investors should have a long-term horizon. They can often exploit trading volatility! I remind investors of this each week, but now is the time to pay attention.
Best of the Week
If I had to pick a single most important source for investors to read this week it would be the advice from Harry Markowitz, the Nobel Prize winning father of modern portfolio theory is 100% invested. (Barron’s ) Why? He is bullish for the long run, but not the very long run. He has much less diversification than usual, because he expects rebuilding in the hurricane aftermath. Check out the whole story, but if you look for lumber, wallboard, glass, bulldozing, mining, and elevators, you can guess his top mega stock picks.
Markowitz may have the same information as everybody else, but he sees things differently: Even as news articles forecast that the stock market was getting too high and had to have a correction, Markowitz didn’t see it as out of line with the economy at all, especially when combined with the benefits of tax cuts and corporations repatriating money they’d kept overseas.
“I’m just looking at the statistics of the stock market—they are not looking one step beyond how the economy is doing or what the economy is likely to do. The economy is likely to rebuild Puerto Rico! We suddenly have a big influx of capital and an incentive to spend it, and we have an increase in supply and an increase in demand. But we are going to have economic activity at least until Puerto Rico is rebuilt, at which time I might be dead.”
This is a great lesson on adapting your portfolio to the most important current themes.
Stock Ideas
Chuck Carnevale channels Peter Lynch in his analysis of Ulta Beauty. His article includes an excellent update on the widely-misinterpreted Peter Lynch approach and a lesson in how to evaluate a growth stock. The Lynch lesson takes experience as a starting point and then brings in serious fundamental research.
I’ve never said, ‘If you go to a mall, see a Starbucks (NASDAQ:SBUX) and say it’s good coffee, you should call Fidelity brokerage and buy the stock,'” Lynch says, some 25 years after his retirement from running Magellan Fund was front-page news.
Tax law effects. The WSJ has an update on impacts . Just as I have written, the analyst changes have been slow to capture these ideas. There is a lot of great analysis in this article. The table of some big companies is only a taste of the story.
Beaten down REITs? Dividend Sensei has some ideas in the beaten-down medical sector.
Analyst psychology as a driver? Stone Fox Capital thinks the direction for Gilead has changed.
D.M. Martins compares the cruise lines and gives the nod to Carnival (LON:CCL). (I like this theme, but currently own RCL).
David Fish updates the list of dividend champions – 3 new members and 23 new challengers.
- Losses on bond funds will nudge many into stocks. Bill Miller sees the tipping point for this at about 2.7%% on the ten-year. That leaves a wide window for stock investors to enjoy – and probably a considerable length of time before real problems ensue.
A wary eye on Washington.
- Normally we get a compromise at the 11th hour. It seemed like the ingredients were there last week, but the situation has gotten worse. Art Cashin opines that this has (so far) had little effect on stocks.
Do you have a plan?
If not, you are a potential victim of everyone selling fear and making their profit from gold, page views, annuities, bitcoin, or newsletter subscriptions. Bill Miller: “Why would you sell because others are selling? You should have an idea of what businesses are worth and buy when there are opportunities”.
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