A Dash of InsightWeighing The Week Ahead - Economic Fireworks

29/6/2014 A Dash of InsightWeighing the Week Ahead: Economic Fireworks?
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http://dashofinsight.com/weighing-week-ahead-economic-fireworks/ 1/17
Weighing the Week Ahead: Economic Fireworks?
oldprof (http://dashofinsight.com/author/oldprof/)
(6/28/14) With the stunning decline in Q1 GDP, the health of the US economy has once again taken center stage. The week ahead is
shortened by a Friday holiday, but is packed with important data releases. It will all be over Thursday morning, when many will quit
early and head for the beach.
In a quiet, low volume trading environment, we could see some early fireworks!
Prior Theme Recap
Last week I expected (http://dashofinsight.com/weighing-week-ahead-fed-behind-curve/) plenty of inflation talk leading up to
the release of the Feds preferred measure, the PCE index. That assessment was accurate. I also speculated that there might be a final
GDP revision exceeding 2%. That was an underbid! The story made plenty of news, but caused only a temporary reaction in stocks.
Bonds strengthened (lower yield) emphasizing the continuing disparity between those markets.
Naturally 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. That is the purpose of considering possible themes for the week ahead.
This Weeks Theme
With the Q114 GDP decline as context, the economic debate is once again wide open. It is time for a mid-year reality check, with
possible fireworks in store. I expect the media and punditry to examine a full range of economic possibilities. Here are the
candidates.
Stagflation Combine economic weakness with inflation and it is the road to the 70s. The Fed is boxed in and between a
rock and a hard place. Watch the early warning signs. Here is an example (http://www.marketwatch.com/story/what-if-janet-
yellen-is-wrong-2014-06-25) of this thinking.
Poor economic policy ObamaCare, tax policy, regulation. (WSJ commentary (http://online.wsj.com/articles/gdps-
obamacare-downgrade-1403738610) reflects this viewpoint).
Exceptional circumstances weather, sluggish health care enrollment, inventories. (Analysis and charts
(http://community.xe.com/forum/xe-market-analysis/yes-first-quarter-gdp-figure-was-anomaly) from Hale Stewart).
Things turned in March noted by those who follow frequent data. (Extensive discussion from New Deal Democrat
(http://bonddad.blogspot.com/2014/06/two-notes-about-q1-gdp.html)).
Expect a rebound weather delayed demand, health care rebounded, inventories will be rebuilt. (Morningstar
(http://news.morningstar.com/articlenet/article.aspx?id=652452)). (Also Jared Bernstein via Mark Thoma
(http://economistsview.typepad.com/economistsview/2014/06/that-big-negative-q1-gdp-revision.html)).
A DASH OF INSIGHT
(HTTP://DASHOFINSIGHT.COM)
29/6/2014 A Dash of InsightWeighing the Week Ahead: Economic Fireworks? -

Same data, many interpretations. Some positions reflect underlying policy and political preferences. Investors must use care, especially
on issues of this type. We must not confuse what we hope for with reality and sound investments.
Which of these viewpoints is correct? As usual, I have some thoughts that I will share in the conclusion. First, let us do our regular
update of the last weeks news and data. Readers, especially those new to this series, will benefit from reading the background
information (http://oldprof.typepad.com/a_dash_of_insight/background-on-weighing-the-week-ahead.html).
Last Weeks Data
Each week I break down events into good and bad. Often there is ugly and on rare occasion something really good. My working
definition of good has two components:
1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially no politics.
2. It is better than expectations.
The Good
There was some encouraging news last week.
Consumer confidence registered 85.2. This beat expectations via the Conference Board. The Michigan Sentiment report
also showed a slight beat. Doug Short updates both indicators (http://www.advisorperspectives.com/dshort/updates/Michigan-
Consumer-Sentiment-Index.php) (and the NFIB optimism index as well). The charts are all great, but I will highlight the
Conference Board result now beating the declining trend, but well off of historic highs.
(http://dashofinsight.com/wp-content/uploads/2014/06/dshort-conference-board.png)

Stock Buybacks support the market. Ed Yardeni shows the trend and the data (http://blog.yardeni.com/2014/06/stock-
buybacks-charge-up-bull-excerpt.html). He describes the causality and warns about the impact of a recession. If this does not
seem like good news, check out TrimTabs (below).
As I have often observed in the past, corporations have an incentive to borrow in the bond
market and use the proceeds to buy back shares when their earnings yield exceeds the
corporate bond yield. Thats been the case since 2004 thanks to the Feds easy monetary
policies under both Alan Greenspan and Ben Bernanke, and now Janet Yellen.
Buybacks are a form of financial engineering since they boost earnings per share whether a
companys fundamentals are improving or not. Theyve certainly contributed to the bull
markets great run in an economic environment that has been widely described as subpar.
(http://dashofinsight.com/wp-content/uploads/2014/06/yardeni-stock-buyback.png)
Earnings estimates grind higher. Brian Gilmartin does a great job on this topic, as well as coverage of many specific
companies. We think of him as the earnings guru. His current update post (http://fundamentalis.com/?p=3811) reflects some
conversations we have had in recent years. I like to think we have both benefited from a focus on the truth in earnings forecasts.
Most observers casually dismiss one of their most helpful sources. Earnings estimates start out as too bullish, mostly when made
two years in advance. By the time the report is announced, the beat rate is over 60%. They have to be right at some point!
Housing data improved. New home sales were up over 18%. Calculated Risk, our favorite source on housing, has a more
measured take (http://www.calculatedriskblog.com/2014/06/comments-on-housing-and-new-home-sales.html) less
enthusiasm about the spike in new home sales (up 2% y-o-y), less pessimism about the decline in existing home sales (reflecting
fewer foreclosures and short sales).

The Bad
The economic news included some negatives as well.
Boomerang kids wont leave. The sluggish recovery is playing havoc with traditional family life. Young adults are returning
home. This can be financial necessity, but it can also make sense. Adam Davidsons NYT Magazine piece
(http://www.nytimes.com/2014/06/22/magazine/its-official-the-boomerang-kids-wont-leave.html?_r=0) attracted plenty of
attention this week. There are implications both for employment and housing.
Margin debt increased at the NYSE. I am scoring this as bad because that is the way it is generally portrayed. Doug Short
posts it with a question mark (http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php),
but others using his work (http://shortsideoflong.com/2014/06/another-look-margin-debt/) are less equivocal. Some also see a
decline in debt as bad, since that triggers the warning for stocks (which is either 3 months or 6 months or a little longer). I am
uncomfortable with indicators that are viewed as positive (or negative) no matter whether they go up or down!
Planned stock buybacks are in a dramatic decline.The overall levels are still high, but down significantly from Q1. (TrimTabs
via MarketWatch (http://blogs.marketwatch.com/thetell/2014/06/25/stock-buyback-announcements-slide-in-a-bad-sign-for-
markets-trimtabs-says/)).
Personal spending disappointed. The personal income gain met expectations with a growth of 0.4%, but spending was only
up 0.2%. (Via Calculated Risk (http://econintersect.com/a/blogs/blog1.php/may-2014-real-personal-income)). Steven Hansen
at GEI (http://econintersect.com/a/blogs/blog1.php/may-2014-real-personal-income) sees this as bad sign for Q2 GDP.
Durable goods orders declined 1%. (See WSJ (http://online.wsj.com/articles/u-s-durable-orders-drop-1-0-in-may-
1403699716)). Also several helpful comparisons and charts from Doug Short
(http://www.advisorperspectives.com/dshort/updates/Durable-Goods-Orders.php).
(http://dashofinsight.com/wp-content/uploads/2014/06/dshort-durable-goods.png)
GDP declined 2.9% for Q114. The decline is much greater than we typically see outside of a recession. Even if the recovery
is continuing, it underscores how dramatically economic performance lags potential. Scott Grannis
(http://scottgrannis.blogspot.com/2014/06/the-bond-markets-pessimism-is-vindicated.html?
utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+blogspot%2FtMBeq+%28Calafia+Beach+Pundit%29)
discusses these relationships, including a good chart on each point:
(http://dashofinsight.com/wp-content/uploads/2014/06/Nom-vs-real-GDP-qoq.jpg)

(http://dashofinsight.com/wp-content/uploads/2014/06/Real-GDP-vs-trend-50.jpg)
The Ugly
Ukraine. The ceasefire in eastern Ukraine is under stress. (Via BBC (http://www.bbc.com/news/world-europe-28069795)).
The Silver Bullet
I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to
demonstrate the facts. Think of The Lone Ranger.
Normally the award goes for a single refutation of a single bad claim. Barry Ritholtz often uses a weapon that is both more modern and
more powerful than the Lone Rangers. Please read his analysis of a general failure
(http://www.bloombergview.com/articles/2014-06-27/when-correlations-lie) in causal reasoning. Here are some recent examples,
cut down with a Gatling gun instead of a six-shooter.
What are a few examples of the single factors that have been making the rounds these days?
GDP: We have never had a negative 2.96 percent GDP report and not gone into recession
Rising Rates: The U.S. stock market doesnt do well when interest rates are rising.
Earnings Surprises: Earnings are good this quarter, better than expected, and therefore, the
markets going higher.
New Financial Products: These new products are being adopted, therefore it means the bull market
is coming to its peak.
Death Cross/Golden Cross: When the 50 and 200 day moving average cross to the upside
(downside), it bodes well (poorly) for any trading vehicle.
Quant Corner
Whether a trader or an investor, you need to understand risk. I monitor many quantitative reports and highlight the best methods in this
weekly update. For more information on each source, check here (http://dashofinsight.com/wtwa-indicator-snapshot/).
Recent Expert Commentary on Recession Odds and Market Trends
RecessionAlert (http://recessionalert.com/our-service/): A variety of strong quantitative indicators for both economic
and market analysis.
Bob Dieli does a monthly update (https://www.nospinforecast.com) (subscription required) after the employment report and also a
monthly overview analysis. He follows many concurrent indicators to supplement our featured C Score. One of his conclusions is
whether a month is recession eligible. His analysis shows that none of the next nine months could qualify. I respect this because Bob
(whose career has been with banks and private clients) has been far more accurate than the high-profile TV pundits.
Georg Vrba (http://imarketsignals.com/): Updates his unemployment rate recession indicator
(http://www.advisorperspectives.com/dshort/guest/Vrba-140626-Weekly-Recession-Indicator.php), confirming that there is
no recession signal. Georgs BCI index (http://www.advisorperspectives.com/dshort/guest/Vrba-140619-Weekly-Recession-
Indicator.php) also shows no recession in sight. For those interested in hedging their large-cap exposure, Georg has unveiled a new
system (http://imarketsignals.com/2014/hedging-bestspy-sh-or-best-combo3-with-the-bestshort-large-cap/).
Doug Short (http://advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php): An
update of the regular ECRI analysis with a good history, commentary, detailed analysis and charts. If you are still listening to the ECRI
(2 years after their recession call), you should be reading this carefully. Doug includes the most recent ECRI discussion, which has
been consistently bearish, including the blown call on the recession.
Doug also continually updates the Big Four indicators used in recession dating by the National Bureau of Economic Research
(NBER). With all of the data for May in the books, it is time for another look at the key chart, but see the full article
(http://www.advisorperspectives.com/dshort/updates/Big-Four-Economic-Indicators.php) for comprehensive discussion.
(http://dashofinsight.com/wp-content/uploads/2014/06/dshort-big-four1.png)
Another great source is Janet Yellens Dashboard (http://www.brookings.edu/research/interactives/2014/janet-yellens-
dashboard?
utm_source=Twitter&utm_medium=Social&utm_campaign=BrookingsInst06101&utm_content=BrookingsInst0610) from
Brookings (HT Jeff Sandene @MarathonWealth (https://twitter.com/MarathonWealth)). This is a wonderful interactive tool.
The Lauren Nassef illustration captures the concept.
(http://dashofinsight.com/wp-content/uploads/2014/06/Yellen-Dashboard.png)

The Week Ahead
We have plenty of news in a holiday-shortened week.
The A List includes the following:
Employment report (Th). The complex, heavily revised report is still the most important evidence for markets.
ISM index (T). Good read on manufacturing trends with some leading qualities. Continuing strength?
Auto sales (T). After the seasonal fluctuations, will strength continue? And check out the F150 small business indicator.
ADP employment report (W). An alternative measurement of private job growth. Deserves more respect.
The B List includes the following:
ISM Services (Th). Covers more of the economy than manufacturing, but still not as influential. Many will be on the way to the
beach by the time this is released!
Construction spending (T). Important sector May data.
Chicago PMI (M). The regional survey most reflective of the national data.
Pending home sales (M). May data, but everyone cares about all things housing.
Trade balance (Th). May data relevant for Q2 GDP.
Despite the start of summer, the speaking calendar includes SF Fed President on Tuesday and Chair Yellen on Wednesday.
While the financial markets have adjusted to the current Iraq story (see here (http://www.breakingviews.com/21152352.article?
h=dcc810731062618da34555347b616ae6&s=2) for confirmation), there is plenty of attention to any breaking news. There is also
the possibility of increased conflict in Ukraine.
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 remains cautiously bullish. The positive elements are modest in strength and uncertainty remains high typical for a trading range
market. This week we were fully invested in three of the top sectors for our trading accounts. That remains our position going into the
week ahead, although some of the strength is outside of the US.
You can sign up for Felixs weekly ratings updates via email to etf at newarc dot com.
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. The current actionable investment advice is summarized here
(http://dashofinsight.com/current-recommendations-for-investors/).
The market still did not provide much opportunity for fresh buys. The gentle upward action is fine for long-term investors and excellent
for those trying out our Enhanced Yield approach.
Here are some key themes and the best investment posts we saw last week.
Often the best advice helps the investor learn what to ignore.
Worry about low volatility. The scary stories say that it reflects dangerous complacency. Dan McCrum at FT Alphaville
(http://ftalphaville.ft.com/2014/06/27/1889342/calm-aint-bad-necessarily/?) highlights some great research from Citi. There is
less volatility in earnings. The research also shows the complete lack of correlation between volatility and stock returns for the
next year. Case closed.
QE has not just propped up asset prices, it has also helped to stabilize economies and corporate
profits. As long as the eventual withdrawal of QE coincides with continued fundamental
stability, then there may be less of an increase in market volatility than many fear.
(http://dashofinsight.com/wp-
content/uploads/2014/06/Screen-shot-2014-06-27-at-8.55.56-AM.png)
Worry about housing. The market is not over-valued, except in a few places. Real estate is local. Other areas are undervalued.
Steven Russolillo has the full story (http://blogs.wsj.com/moneybeat/2014/06/24/housing-isnt-overvalued-except-in-these-10-
spots/) with some good tables. The undervalued areas seem to include much of my part of the world while overvalued areas are
in California.
Avoid Glamour Stocks. A great company is not always a great stock. Josh Brown has (yet another) post helping the
individual investor. He cites James OShaughnessy on the subject of value versus momentum. Check out the post
(http://www.thereformedbroker.com/2014/06/25/james-oshaughnessy-why-investors-should-avoid-glamor-stocks/) and watch
the video.
Bond funds are a continuing source of risk. Is there really consideration of an exit fee? I rather doubt it, and also question
whether it would work. The very idea of this discussion is something of a warning. (Fortune
(http://fortune.com/2014/06/23/federal-reserve-bond-fund-fees/)). People expect these investments to represent the safe part
of their portfolio. If we really do get the inflation that the Fed is seeking, interest rates will rise and bond prices will fall.
(http://online.barrons.com/news/articles/SB50001424053111903927604579628353649352222?mod=djemb_mag_h)
Worry about bogus charts.
(http://online.barrons.com/news/articles/SB50001424053111903927604579628353649352222?
mod=djemb_mag_h)Stick a fork in the 1929 chart
(http://blogs.wsj.com/moneybeat/2014/06/26/time-to-officially-stick-a-fork-in-that-1929-chart/)
says Steven Russolillo. This chart was the most circulated in market circles. It would not die. It was
costly for many investors. Meanwhile, Philosophical Economics has a very dramatic conclusion that
you will probably not believe. So read the full post
(http://philosophicaleconomics.wordpress.com/2014/06/15/whos-afraid-of-1929/). If you were a 30-
year investor, you would have done better starting in 1929 than in 1980 the worst of times (using
CAPE and other indicators) versus the best of times.
(http://dashofinsight.com/wp-content/uploads/2014/06/BN-DL084_1929pa_G_20140626115826.jpg)
On the positive side, there are some good stock ideas.
Goldman Sachs shares some choices (via Steven Russolillo at MarketWatch
(http://blogs.wsj.com/moneybeat/2014/06/23/goldman-sachs-here-are-15-stocks-to-buy/) for the underlying rationale). Skeptics
may ask why they would share ideas, but that is the modern method of the big firms. They need to show a little. We own some of the
names and others are on our watch lists for various programs, so the ideas are interesting.
(http://dashofinsight.com/wp-content/uploads/2014/06/MW-Goldman-Buy-LIst.png)
If you are worried about possible market declines, you have plenty of company. This is one of the problems where we can help. It is
possible to get reasonable returns while controlling risk. You can get our report package with a simple email request to main at newarc
dot com. Also check out our recent recommendations in our new investor resource page (http://dashofinsight.com/tips-for-
individual-investors/) a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful
and I love and use feedback).
Final Thought
The weakness in Q1 GDP is not consistent with the wide range of economic data that we track. There is no indication of a recession
using the indicators tracked by the NBER, even during the first quarter. Growth has been sluggish, but steady. This feels like a
recession to most average people, who consistently respond to surveys that the Great Recession has not ended.
Meanwhile, the business cycle hit a trough in 2009 and shows no sign of reaching a peak. Michigan economist Justin Wolfers, writing
in the New York Times, observes as follows (http://www.nytimes.com/2014/06/27/upshot/job-growth-is-up-production-
down.html?rref=upshot&_r=0):
The most important indicators of our economic health are telling very different stories. On
Wednesday, news (http://www.nytimes.com/2014/06/26/upshot/economy-in-first-quarter-
was-a-lot-worse-than-everybody-thought.html?rref=upshot) reports made much of the fact that
gross domestic product fell at an annual rate of 2.9 percent in the first quarter of this year, a decline
largely attributable to bad weather. That brings growth over the past year to a disappointing 1.5
percent. Yet the labor market continues to deliver good news, and over the same period, the
unemployment rate fell by more than a full percentage point.
He notes that the past year has defied the relationship between unemployment and economic growth, Okuns Law. The chart below
shows that current results represent a dramatic outlier.
(http://dashofinsight.com/wp-content/uploads/2014/06/Defying-Okun.png)
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I do not expect any instant economic solutions, but the evidence supports continued reversion to the long-term growth trend. This will
continue until we see more signs of a tight labor market not just more jobs, but more hours and higher wages.
That is why the data this week are especially important. Any break from the recent trend of modest growth could lead to some early
holiday fireworks!
oldprof (http://dashofinsight.com/author/oldprof/)
29 Jun. 2014
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