By Jeff Miller :
The economic calendar is normal, with an emphasis on inflation data. The week will begin with analysis of the annual Berkshire Hathaway meeting, the wisdom of Buffett and Munger, and a multi-hour CNBC program including Warren Buffett, Charlie Munger, and Bill Gates. While the questions will range widely, the punditry will soon turn to the mystery of the moment:
Why are stocks stuck in neutral?
Last Week Recap
In my last edition of WTWA I asked whether the avalanche of economic data would send interest rates higher. That was part of the discussion, particularly around the FOMC announcement. At the end of the week, Elon Musk stole the headlines. Friday's trading seemed to leave pundits bewildered. The reports on the economy were fine, but not super-strong. Inflation expectations and interest rates did not change.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. I especially like the version updated each week by Jill Mislinski. She includes a lot of valuable information in a single visual. The full post has even more charts and analysis, so check it out.
While the market was unchanged for the week, once again there was action along the way. The trading range was about 3.2%. I summarize actual and implied volatility each week in our Indicator Snapshot section below. As you can see, volatility has been moving lower.
Each 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!
Feel free to add items that I have missed. Please keep in mind that we are looking for current news, especially from the last week or so. WTWA is not about long-term concerns like debt. These are important, of course, but not our weekly subject unless there has been some major change.
- Rail traffic remains strong.Steven Hansen's focus on "intuitive sectors" and year-over-year rolling averages filters out some noise and illustrates the recent growth spurt. Calculated Risk is even more enthusiastic, calling it the "best April ever" for intermodal.
- Corporate earnings continue to exceed expectations. This is especially interesting because of the unusual pattern this quarter. Expectations were not reduced significantly before the reports. These are true surprises. FactSet calls it the highest beat rate since they began compiling data in 2008.
- Investor sentiment is "less bullish" reports David Templeton ( HORAN ). He provides a nice summary of several sentiment indicators. Here is a chart of one you seldom see, the net exposure of active investment managers. It has declined from a high of 120 (leveraged long by 20%) to 52.6 (nearly neutral). Some managers are 100% short.
- Employment shows continuing solid gains. The market reaction seemed to confirm a "Goldilocks" report - continuing strength, but not enough to stimulate an aggressive Fed reaction.
- Unemployment falls to 3.9% but wage growth remains weak ( Dean Baker ).
- Oil prices have moved higher.New Deal Democrat notes this move as part of his regular update of high-frequency indicators. Most of these remain neutral to positive. See also the WSJ Energy Journal .
- Gasoline prices increased again - ten cents in the last two weeks. Some, but not all, of this is seasonality. Re-imposition of Iran sanctions would push this recent trend further. ( GEI ).
- ISM manufacturing and services indexes both missed expectations, although the readings remain high. ( Bespoke ).
- Pending home sales increased in 0.4% in March, but declined 3.0% y-o-y. ( Calculated Risk ).
Huge ER bills for little or no treatment? $5000 for an ice pack and a firm statement refusing further care? This is a problem that deserves attention. ( Vox ).
The Visual Capitalist always has informative and stimulating charts. For those in the US, this is an especially important source of perspective. Could you have listed the top ten languages? The top five?
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 economic calendar is normal, with an emphasis on labor markets and inflation data. Earnings season continues, and Fed members will be on the speaking circuit. If the week is like those from recent months, a surprise event may well claim the spotlight.
Next Week's Theme
The week begins with a post-mortem on the BuffettFest, so expect a start with some good advice about value investing. This will not last long, since it provides little grist for the daily demands of financial media. The recent market mystery compares a market in neutral with a streak of (apparently) good news. I expect pundits and financial writers to be asking:
Why are stocks stuck in neutral?
As always, there are several suggested explanations.
- A sideways correction. This short and crisp terminology comes from a CNBC segment featuring Michael Santoli .
- Cage match? Briefing.com 's Patrick J. O'Hare provides a list of current worries, asking "What is on the market's mind?"
- A narrowing wedge, from which a breakout must soon occur. ( Eddy Elfenbein ). Eddy thinks that repeated tests of support increase the likelihood of it failing. I'm not sure how you find solid evidence for such a concept, but I always thought the opposite. See SpeedTrader for a discussion.
- A normal correction for a market that "got ahead of itself" early in the year.
- An irrational reaction to a 3% yield. ( Ed Yardeni ).
Contributing to the stock market's agita so far this year has been the prospect that the 10-year US Treasury bond yield may be on the verge of rising above 3.00%, a level that for some reason is perceived as particularly dangerous for stocks. I suppose that's mostly because a few widely respected market gurus have been warning that the risks of a bear market in stocks increase above this totally subjective threshold level. Perversely, at the same time, there has been some consternation over the fact that the yield curve has been flattening. That implies that the bond yield hasn't increased fast enough relative to the federal funds rate and relative to the two-year Treasury note yield! So what are we supposed to be rooting for?
- Market prices do not reflect value. "Davidson" (via Todd Sullivan) writes:
- "Davidson" (via Todd Sullivan)
Market prices are accepted by many as efficient reflections of 'value'. For those who study economics and individual business activity, the reality is quite different. Economic and individual business activity is the basis of investor perception which then becomes reflected in market prices. The diagram stylizes how human activity in seeking to improve one's standard of living works its way into economic/business fundamentals and eventually emerges as perceptions of future value. Market prices are simply what the majority of investors believe something will be worth at some point in the future. Market prices at any point in time reflect hope/expectation, not current value.
As usual, I'll save my personal conclusions for today's Final Thought.
We follow some regular featured sources and the best other quant news from the week.
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
Short-term trading conditions have turned negative. The rating is now borderline for our trading models. Many approaches will not work in such stormy weather. We continue to monitor the technical health measures on a daily basis. The long-term fundamentals and outlook are little changed. The long-term technical health is back to strongly bullish.
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.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. With some important fresh data to consider, it is time for an update of their excellent chart of the Big Four Indicators .
This chart is a great way to maintain perspective in a world with too many "experts" speculating about the economy.
John M. Mason posted a nice explanation about why long-term interest rates are not under the Fed's control - at least not directly. He suggests that the longer-term interest rates can be split into two component parts: the expected real rate of interest and the expected rate of inflation. The former, over time, is expected to be equal to the real rate of growth in the economy.
This approach is precisely why I provide the relevant data each week in the Indicator Snapshot.
The Fat Pitch joins the growing group seeing a 2018 recession as very unlikely.
Charlie Bilello questions the oft-asserted relationship between bond yields and the real economy. His post provides plenty of charts and tables for your own study. He wisely includes inflation as a factor in the analysis.
Insight for Traders
Check out our weekly Stock Exchange post. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we highlighted three anomalies that beat the market. As usual, we discussed some stock ideas and updated the ratings lists for Felix and Oscar, this week featuring the NASDAQ 100 stocks. 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.
While I emphasize trading in the Stock Exchange series, it often has implications for long-term investors. It is worth a visit.
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 Nick Maggiulli's ( Of Dollars and Data ) explanation of why The Process Matters . Here is the opening paragraph:
On the first day of ceramics class the teacher announced that the students would be split into two groups. One group would be graded on the quantity of the work they produced while the other group would be graded on the quality of the work they produced. The "quantity" group had to create as many clay pots as possible over the next few months while the "quality" group had to produce a single clay pot as best they could.
Months later as the students turned in their pots to be graded, the teacher came to a surprising realization…
From this starting point, he delves into an examination of differing definitions used by value funds in setting their universe. There are several informative charts, but I cannot do justice to the analysis with a single choice. And he has given me a new book for my reading list!
In fact, there are over 55 ETFs with "Value" in their name and even more mutual funds that are value oriented. While it is tempting to throw all of these products under the same label of "value investing", you can't commoditize them. Some are passive. Some are active. Some are more concentrated. Some are less concentrated. And I could go on. The point is that they are all different because the process they use to select their stocks is different.
The analysis is first-rate, but the general principle has wide application. Here are two examples I saw in the last few days.
- Brett Steenbarger explains about Turning Trading Mistakes into Trading Successes . "Every day of trading provides a day's worth of review and learning," Brett writes. To make this work, you must try things and observe the results.
- Charlie Munger notes that "Harvey Weinstein has done a lot for improving behavior."
And finally, there are important profitable advantages. This approach helped me to get it right about the European "crisis" when nearly everyone was going wrong. The punditry insisted on comprehensive plans and solutions. It is often more effective to try something and adjust to the results. Here is a post from the 2012 era .
Reaction to the Sohn Conference. The WSJ brings back the darts , going back to an era when they had a weekly contest and actual pages of quotes. Here is the lineup.
Table-pounding buys from value investor David Katz. ( CNBC ). We always review ideas from good source before we make our decisions. We hold none of these now, but we have in recent times.
REITs? Some are trading at 15% discounts to the underlying assets. ( WSJ )
Short Selling? Amanda Cantrell's interesting account of a recent conference and the Buffett weekend reminded me of the Doug Kass courageous appearance in 2013. He presented reasons for shorting Berkshire Hathaway in front of 55,000 rabid investors. He certainly did not convince them, and for his sake, I hope he covered. The stock is up about 75% since then.
Here is the Cantrell account:
At the event - entitled "The Art, Pain and Opportunity of Short Selling" and put on by former hedge fund manager Whitney Tilson's Kase Learning - manager after manager pitched short ideas, with several making compelling cases as to why the stock prices of their short targets are sure to fall. For all their confidence, making money off short-selling is notoriously easier said than done. (Tilson should know: He shuttered his hedge fund , Kase Capital Management, after years of underperformance and started Kase Learning earlier this year, which offers investing classes to current and aspiring managers.)
She reports that the participants were quite optimistic --- about their prospects, not about stocks!
Seeking Alpha Senior Editor Gil Weinreich has expanded his excellent series for financial advisors (and serious individual investors) to include some podcasts. This week I especially enjoyed his timely post, Mom As Financial Advisor , with some ideas about how to teach your adult children about financial responsibility. I also liked his suggestion of Mark Ambruster's analysis of some popular forecasts by financial experts.
Abnormal Returns is always worth reading, with many links on an array of interesting topics. Wednesday the focus is on personal finance . There always several good choices. My favorite this week was a J.D. Roth piece on the attractions of finding a cheap place to live . (Mrs. OldProf is laughing at this, after 30 years in the Chicago area. When we moved here, we adopted a "doubling rule" compared to Wisconsin - applying to anything other than consumer goods).
The article is great, so please take this map as a mere sample.
Watch out for…
Scams against the elderly. Would you believe $37 billion per year with 60% attributed to family members? Most WTWA readers will not fall for these fake pitches, but we all know someone who might. Be proactive. Take a look at your friend list (formerly known as a Rolodex) and think about possible candidates.
The efforts to describe the market as a human, or an animal, or two teams make it easier to write about it but do not aid understanding. Such comparisons or heuristics are not helpful if key points are lost in seeking simplicity. The key to understanding the current market rests partly in how to determine a fair price.
If Mr. B is asked about the current market, do not expect an explanation.
"Nobody buys a farm based on whether they think it's going to rain next year," he said on CNBC's " Squawk Box ." "They buy it because they think it's a good investment over 10 or 20 years."
Simply put, Buffett decides a business is worth investing in because it will last, not because it's doing well right now.
This is consistent with the explanation of Buffett's own teacher, Benjamin Graham .
Graham's favorite allegory is that of Mr. Market , a fellow who turns up every day at the stock holder's door offering to buy or sell his shares at a different price. Usually, the price quoted by Mr. Market seems plausible, but occasionally it is ridiculous. The investor is free to either agree with his quoted price and trade with him, or to ignore him completely. Mr. Market doesn't mind this, and will be back the following day to quote another price. The point is that the investor should not regard the whims of Mr. Market as determining the value of the shares that the investor owns. He should profit from market folly rather than participate in it. The investor is best off concentrating on the real life performance of his companies and receiving dividends, rather than being too concerned with Mr. Market's often irrational behavior. 
And finally, the advice of top investment manager Ken Fisher ( via Meb Faber ). "If you're worried about things are going to be worth next week...you're going to make yourself way poorer 20 years from now."
Financial pundits cannot endorse this approach since it would leave them too much airtime and column space to fill!
The next part of the explanation is the difference between trading and investing. I recently tried to explain the difference between the daily market gyrations and the best approach for investors. ( Trading, Fast and Slow ). Investors who read this will find it easier to ignore the noise of daily market moves and stick to the signal of their data. For example, if stocks declined another 14%, would it tempt you to buy? If so, get your shopping list ready. The forward P/E on the S&P 500 has gone from 18.6 to 16.
Most people focus on price, not value, so these "sideways corrections" often go unnoticed.
Whether you are trying to preserve wealth or to build your assets, there are some great opportunities right now. If you are having trouble pulling the trigger, organizing your thoughts, or finding attractive stocks, send a note to main at newarc dot com. I have written papers on each of these topics. We will happily send some free resources and provide a consultation if you wish.
I'm more worried about:
- Iran. The deadline for US withdrawal from the agreement is nearing. There are still no signs of progress. Estimates suggest that Iran sanctions could move oil prices higher by $10 bbl.
- Deterioration in the tariff and trade talks. The high-level meetings have produced no progress on an issue of great economic significance. This is the most significant issue for the market, and it remains a rhetorical playground for world leaders. We might be comforted a bit. Mr. Buffett expects a resolution because "…both countries will recognize the long-term benefits of free trade and it's unlikely that trade between the two will grind to a halt. 'It's just too big and too obvious that the benefits are huge and the world is dependent on it in many ways for its progress,' Buffett said".
I'm less worried about:
- North Korea. The upcoming Summit provides an attractive opportunity. Perhaps the time is right.
- Seasonality and other calendar factors. At this juncture, the fundamentals of the market are more important.
See also This Week In Money - May 5, 2018 on seekingalpha.com