Tuesday, February 16, 2010

Weighing the Week Ahead: Are You Scared Yet?

If you find the current market action frightening, you are not alone. There is a bull market in disaster predictions, with a chorus of pundits predicting "another 2008." Sentiment indicators show increasing fear. Improvement in corporate earnings is seen as more evidence that something is wrong. After all, a market that cannot rally on good news is showing weakness.

The chart of the S&P 500 from the last year makes the case for a market that moved too far, too fast. Some see a new bearish leg -- not a correction but a major move to the old lows.

There is another perspective. Conditions are much different from the time of last March's low and also from the October, 2008, post Lehman period. A decline of ten percent or so after a big move is to be expected. Let us look at the S&P 500 with a two-year time frame.

The indicators in the two charts are the same, but the context is dramatically different. The fear from 2008 is ever with us. Patrick J. O'Hare, writing Briefing.com's regular feature, The Big Picture, summarizes it this way:

After the credit crisis of 2008/2009, which clearly presented a systemic risk few portfolios were positioned to deal with, there will be hyper-sensitivity to staying out in front of the next systemic risk.

To this point, consider for a moment how often the word "bubble" is tossed out to explain any uninterrupted rise in asset prices. Before the technology stock crash of 2000, the word "bubble" was rarely invoked in the marketplace, and when it was, it was typically used in association with an exposition on the South Sea Bubble of the early-18th century.

What there is today in the stock market is a bubble in the use of the word bubble

That is a clever and accurate summary. He might have added that black swans are not found in herds.

Last Week's Action

Let's start with a look at the key data from last week. As usual, I am not trying to be comprehensive, nor am I taking a viewpoint. I will highlight what I found significant.

The Good

The earnings news is petering out for this season, but the general pattern of strength continues. Positive guidance is beating negative guidance by the widest margin in nearly a decade, according to Bespoke Investment Group. This is unusually good news, and eventually it will matter.

Some celebrated the weekly decline in initial claims. This reverses a couple of weeks of poor data. I disagree. The weekly series is just too noisy. Next week's data will be distorted by weather, as will next month's payroll employment data. (The payroll survey is done during the week including the 12th of the month).

The Bad.

The trade balance was a bit worse than expected and inventories a bit lower. The revisions will make the 4th quarter GDP increase lower. The revisions to the initial estimate of GDP come as we get more data. The news is not good, but neither is it some big conspiracy as some maintain.

Regular readers know that I find the University of Michigan sentiment indicator to be important and helpful. This month's reading was lower than expected, and certainly not at the bullish levels of the ISM. This is a helpful indicator for employment and job creation, so the report was bad news.

The bond auctions were weak, with long-term rates moving higher. The ten-year has moved to about 3.7% and corporate spreads have also widened. This is bad for stocks, since corporate bonds are a viable asset allocation alternative.

The news about Greece is certainly a negative. Regardless of the outcome, investors need to worry about the extent of sovereign debt problems in Europe and what it means for the U.S.

Briefly put, there was plenty of negative news.

The Ugly. Volatility! When the market makes major moves lower on little news, and seems dependent on Germany's attitude toward Greece ----- well, that is a problem.

Much of this translated into a stronger dollar. While I have demonstrated that a strong dollar is just fine for stocks in the long run, the current relationship is a strong negative correlation. The hot money sees a pattern like this and it becomes a self-fulfilling prophecy -- at least until it quits working.

The Week Ahead

My focus for next week is on Wednesday. Building permits are a good leading indicator of construction activity. (These cost money and reflect actual plans). Industrial production is also important.

I do not find the "leading" indicators to be very helpful nor am I concerned about the PPI and CPI right now. I do not expect any surprises from the Fed minutes.

The European news and the dollar will continue to be important.

Our Trading Forecast

Our own indicators (see our regular ETF updates for an explanation) continue as bearish, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

a) Only 13% (down from 67% two weeks ago) of our ETF's have positive ratings. This is extremely weak.

b) The median strength is -22 (down from -15 last week), very negative.

c) 87% (up from 35% two weeks ago) of the sectors are in the "penalty box," showing much higher risk than in recent weeks.

d) Our Index Package has a negative rating. We own SH and DOG, the inverse ETF's for the S&P 500 and the DJIA.

A Helpful Insight

This is a good time for investors to think about long-term needs and goals. There are some simple solutions for those who are afraid of a repeat of 2008.

I had some reader questions after last week's update, wondering whether asset allocation models had triggered. Mine have not. The "correction" is still relatively small when compared to the recent gains.

We watch the asset allocation carefully for clients, and the indicators are closer to a conservative stance, but not there yet and certainly not short.

The average investor can try to do this at home. There are plenty of ideas online. You need to find a good method, continually update your indicators, avoid emotion, and execute the trades in a timely fashion. Few investors can do this, even when trying to follow a "lazy" portfolio. That is one reason why they trail the market by 4 percent a year while top advisors beat the market by solid margins.

Unless you are exceptional on these fronts, you might look for a good financial advisor. If you do, insist on someone who has personal service -- who understands your specific needs, risk tolerance and requirements. If the fees were low enough, and the stock picks were good enough, this would be better than you could do on your own. Over many years, it might be the difference between a comfortable retirement and a few more years of work.

Whatever you do, you should still pay careful attention to your investments. We no longer live in a "buy and hold" world.


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