The Week Ahead: Will Falling Earnings Sink The Market?

Recent Expert Commentary on Recession Odds and Market Trends

finally admitted to the error in their forecast, but still claims the best overall record. This is simply not true. I rejected their approach in real time during 2011 and also highlighted competing methods that were stronger. Until we know what is inside the black box (I suspect excessive reliance on commodity prices and insistence on unrevised data) we will be unable to evaluate their approach. Doug is more sympathetic in his last update. While I disagree, it will require a longer post to elaborate.

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.”

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.

combination of models to do gradual shifting to and from the S&P 500.

This week Georg has an improvement of the Shiller P/E CAPE ratio method . Unlike the widely-followed Shiller method, Georg’s approach has the advantage of actually generating some “buy” signals! (And as I have frequently noted, I am a fan of Prof. Shiller, who owns stocks and advises others to do the same). Current readings show that stocks are “not greatly overvalued, nor likely to crash anytime soon.”

New Deal Democrat, in addition to his must-read, midyear update on four crucial long leading indicators – those used by Prof. Geoffrey Moore, founder of ECRI. I believe that the ECRI performance would have been better had they stayed with these methods.

See the full post for charts and discussion of each, but here is the conclusion:

While not every long leading indicator is making new highs, and in particular corporate profits have stalled, the other indicators solidly suggest that this economic expansion will last at least through the 2nd quarter of 2016.

This week brings some important economic data.

The “A List” includes the following:

• Housing starts and building permits (F). Is the rebound for real?
• Michigan sentiment (F). Good concurrent read on employment and spending.
• Retail sales (T). What happened to the gasoline savings?
• Initial jobless claims (Th). The best concurrent news on employment trends, with emphasis on job losses.
• Industrial production (W). Volatile series, but helpful in GDP estimates.

The “B List” includes the following:

• PPI (W). Inflation data remains of little interest until and unless we see a few hot months.
• CPI (F). See PPI.
• Beige book (W). Anecdotal information for the next FOMC meeting.
• Crude oil inventories (W). Current interest in energy keeps this on the list of items to watch.
• Wholesale Inventories (F). May data relevant to GDP.

As usual, I have little interest in the regional Fed surveys. There is plenty of FedSpeak in addition to Chair Yellen’s Congressional appearances. Expect further news from Greece and China, but both are hard to game.

Options expiration may add some volatility, especially if overall trading volume remains low, or we get a big move early in the week.

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 continued a neutral stance for the three-week market forecast, but it is verging on turning mildly bearish. The confidence in the forecast remains very low with the continuing extremely high percentage of sectors in the penalty box. Despite the overall market verdict Felix has been mostly invested in three top sectors. For part of the week this included a ½ size position (leaving trading accounts 67% long) in some inverse fund hedges. For more information, I have posted a further description — here ).

Dr. Brett Steenbarger has another powerful and authoritative article helpful both to traders, and also to nearly everyone else. He shows how a simple technique – keeping a journal – can greatly improve your performance. You need to read the full article to see how and why this works. It is not enough just to write.

…journals of the least successful participants served reporting and venting functions. That is, the least successful professionals used their journals to report on events of the day or week and to express their thoughts and feelings about those events.

Conversely, the journals of the most successful money managers served learning functions. The journal entries specifically analyzed what had happened in the recent past, but then went further to frame goals for going forward.

Insight for Investors

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 Investors and 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.

In Part Two of my series on risk I used the Chinese market as an example of headline risk. My main objective is to explain how to navigate the ever-threatening headlines. Along the way I share a few ideas of how you might profit from stocks with Chinese exposure.

Other 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 Sarah Max’s cover story in Barron’s, . The article is loaded with great advice, especially for the average investor. How do you reduce the volatility of a stock portfolio, when bonds have become risky? Here are some key points:

• Quoting Robert Johnson, CEO of the American College of Financial Services — “If you lock in bonds at these levels, you’re locking in a purchasing-power loss.”

  Not long ago, the notion of a no-bond portfolio would have seemed crazy. But what’s really crazy, says Johnson and many of his peers, is clinging to the conventional wisdom. “What are bonds supposed to do? They’re supposed to preserve wealth, provide periodic cash flow, and hopefully some price appreciation,” he says. At the moment, however, they aren’t offering much in the way of income, and there is a real possibility that investors could lose money.

• Investors should consider individual bonds rather than bond funds. You can choose to hold a bond to maturity. The fund manager may not, or may not have a choice in the face of redemptions.

  That exit may be already starting. In the first five months of the year, investors put more than $75 billion into taxable and municipal-bond funds, according to Lipper. But in June, the trend turned, with investors withdrawing a net $17 billion. If that presages a bigger exit, bond funds could fall sharply.

• Asset allocation is an individual matter

  There was a time when bonds could do it all—provide stability, income, and capital appreciation. Those days are over. Now, investors need to pick their focus. And that focus should be determined by an investor’s need, rather than a hackneyed asset-allocation plan that decrees 55-year-olds dump 55% of their assets into bonds.

  But even if the conventional wisdom no longer holds true, the advice is very much the same as it ever was: Know thyself as an investor, and construct a plan that suits your timeline and temperament.

This article and the companion pieces are well worth the price of this week’s issue. We do all of this for clients, but some readers may be able to take these important steps for themselves.

Stock Ideas

Energy is ready to rebound according to the investment newsletter writers with the best records on oil prices (via Mark Hulbert ). The article includes both technical and fundamental reasons and suggests several undervalued stocks in the sector.

I am a fan of iRobot (NASDAQ:IRBT) which has not. His rationale is quite similar to ours. Readers would benefit from following his future work.

Alpha Architect analyzes the performance of the most attractive sectors on a value basis for the first two quarters of 2015. Health care did great, while energy was the worst. The payoff from value investing does not always show up in six months.

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 this story about retirement calculators.

Value versus Momentum

There are many successful investment approaches. In the WTWA posts we usually describe momentum as a trading approach, normally as practiced by our “Felix” model. Value investing is what we do in our long-term stock program. Ben Carlson has a nice explanation of the difference, including some data. Here is an important takeaway:

As with any strategy that has been proven to work historically, there are usually two explanations given — either the strategy takes more risk and is compensated for those risks or there are behavioral factors involved that allow the premium to persist. To me, the behavioral explanation always makes more sense, because really the only way for one investor to outperform is for another investor to underperform. To do better you have to be able to take advantage of someone else’s mistakes. This is the foundation that any viable long-term investment strategy rests on.

Ben Carlson, providing a little calm in a volatile week, contributed a helpful and humorous post on who would benefit from a market correction. Example: Everyone who’s been saying volatility is a “second half story.” And: That co-worker of yours who told you in 2012 that they were going to wait for a 10% correction until they put their 401(k) contributions back into the market.

If you are a realist, you should expect this to be a tough quarter for earnings comparisons. Most of the factors cited in the introduction were indeed headwinds.

And the market paused.

We are left with the question of whether we are at an inflection point for earnings and for stocks. While I understand the current caution, I remain optimistic for the long term for the following reasons:

1. There is no recession on the horizon. This is the biggest threat to stocks.
2. The Q1 economic weakness was (for various reasons) overstated on GDP.
3. The currency issues are stabilizing, and can be mitigated with appropriate stock choices.
4. Stock buybacks improve per-share earnings. (Unlike others, I do not mind getting a bigger piece of a smaller pie).
5. P/E multiples improve when investors have more confidence in the future. That is coming.
6. As usual, the estimate reductions have probably set the bar too low. Here are the past results from FactSet;

Stocks in the sectors I have recommended showed solid gains in a soft market in the first half of 2015. I am looking for more of the same as well as a generalized rally.

This said, it might take another quarter of earnings results to convince the naysayers.

Patience is a virtue – and often necessary for investors!

Correction

Last Week’s WTWA stated that Greek debt was equivalent to 30 hours of Walmart (NYSE:WMT) revenue. The source I quoted accurately described this as the debt to the IMF, the potential default, not the total national debt. I always try to be completely accurate, and I regret this misstatement.

Written By: Jeff Miller