Are Investors Too Complacent?
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The economic calendar is very light and interrupted by the mid-week holiday. We can always see volatility when volume is low, but many market participants will be on an extended holiday. This includes much of the A-team punditry, but someone will be left to fill the airtime. Some will continue the outlook theme I covered last week, but I expect many to be asking:
Are investors too complacent?
It is an interesting question, especially considering recent events that suggest danger to many observers. As usual, I’ll include a range of ideas and offer some comments on each.
Last Week Recap
In my last installment of WTWA, I took note of the big economic calendar but predicted that most would prefer to discuss 2020 market forecasts. That was an accurate guess. The week was filled with such reports. The chart below shows one that I find particularly interesting. It does not represent the forecast of a single person. As John Butters (FactSet) explains, he looks at the median target price estimates from analysts covering the stocks, the same people generating earnings estimates. The prices are then aggregated to generate a forecast for the entire S&P 500 index. This contrasts with the “top-down” analysts who work from expectations for the economy, interest rates, and the most likely P/E multiple.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring the version from Jill Mislinski who combines a lot of important data into a single, readable chart.
The market gained 1.6% for the week. The trading range was only 1.3%. This can happen because I measure the weekly change based upon the prior week’s close. The trading range reflects prices during the actual trading hours, reflecting gains from last Friday even on the low points for the week. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.
Which countries lead the world in scientific publications. Statista reports the numbers. Are you surprised by anything?
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!
New Deal Democrat’s high frequency indicators are an important part of our regular research. The results remain positive in both the long- and concurrent-time frames, but the short-term forecast has turned negative. NDD continues to highlight the metrics to watch if concerned about manufacturing weakness spreading to the consumer.
- A government shutdown was averted. And the USMCA trade bill was passed. The necessity of action generated some compromise even amid the impeachment rancor. (The Hill).
- Homebuilder confidence hit the highest level in 20 years. (Diana Olick, CNBC).
forecasting a big increase in single-family starts Diana Olick
After increasing just over 1% annually this year, growth in single-family housing starts will accelerate to 10% during 2020 and top 1 million new homes in 2021, the group predicts. That would mark a post-recession high but is still far below the annual peak of about 1.7 million single-family starts in 2005 and the 1.2 million annual pace experienced in the late ’90s.
Single-family housing starts have been improving steadily since May, and building permits, an indicator of future construction, are also trending higher.
“It will likely take several years, even at a more robust pace, for new construction to address the existing pent-up demand for additional housing, as suggested by a still-increasing share of 25- to 34 year-olds living at home with their parents,” according to the report.
- Housing starts (Nov) increased to a SAAR of 1365K, surpassing expectations of 1340K and October’s upwardly revised 1323K. Despite the slow start to 2019, Calculated Risk observes that the strong finish means that starts will be higher in 2019 than in 2018.
- Building permits for November reached 1482K (SAAR) beating expectations of 1400K and October’s 1461K.
Industrial production reversed
The rebound in vehicle output associated with the resumption of normal operations at GM will be a plus going forward. But, we still think that it will be second and third order effects of the trade war that will have the greatest bearing on how this sector performs going forward.
What are the second and third order effects? Stopping the importation of Chinese steel through a tariff is the first round effect of the trade war. The diminished use of trucks to haul the steel is the second order effect. The diminished demand for fuel and truck parts are part of the third order effects.
Ending the trade war will diminish the problems that starting the trade war created. But the adjustments to the supply chain will take some time.
JOLTS again hit a sweet spot. Labor markets remain strong, but not too tight. Job openings registered 7.267M for October up from September’s 7.032M, but that is only one element to consider. The coverage of this report is so poor that I am devoting some extra space this week. Below are charts from the BLS site illustrating the most important elements of labor market structure.
Core PCE prices showed a gain of 0.1% in November, the same rate as October and lower than expectations of 0.2%. This is good because the Fed will not feel any pressure for a rate hike.
Mortgage purchases remain strong. The pace continues as the best in a decade.
Michigan sentiment for December registered 99.3 in the final reading, slightly beating the prior 99.2 and expectations of 99.1. Jill Mislinski publishes my favorite chart of this series, including GDP and recession data with the meaningful history.
Personal income for November increased 0.5% surpassing October’s upwardly adjusted 0.1% and expectations for a gain of 0.3%. “Davidson” (via Todd Sullivan) calls the last twelve months “one of the most valuable investment lessons of the last 10 yrs.” He points to the extreme pessimism of Oct 2018-Dec 2018.
Personal spending was also slightly higher than expectations, an increase of 0.4% versus 0.3%. October was also 0.3%.
Initial jobless claims declined to 234K from last week’s 252K. This was still above the expected 226K and far above recent levels. Analysts continue to watch possible seasonal effects from the late Thanksgiving.
Leading economic indicators were flat for November, beating October’s downwardly revised decline of 0.2%. Expectations were for a 0.1% gain.
Existing home sales for November were 5.35M (SAAR) worse than the prior 5.44M and expectations of 5.45M. Calculated Risk focuses on low inventory as a key explanation. Bill also updates is chart showing the continuing improvement on a year-over-year basis.
New climate records this decade. Check out the six animated time series.
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 has few reports. It is a holiday shortened week, split in the middle. Congress has gone into recess. Many would expect a time of low volatility, but we sometimes see big moves on small volume. And we cannot ignore the tweet factor.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
It is a quiet time which will naturally lead the Flight B Pundits, taking over for the week, to ask:
Have investors become too complacent?
Eddy Elfenbein has his usual level-headed perspective on complacency. Here are two of his many good points:
I don’t know how many people would have predicted that the stock market would have a low volatility and multiple new highs during an impeachment, but that’s exactly what’s happened.
The mood has shifted and investors seem much more confident than they did over the summer. Remember in August when the two-year Treasury yield jumped above the 10-year yield for about half an hour? The “inversion” scare was good for about a week, as market commentators talked about “being very concerned.”
One of the big mistakes investors make is confusing financial markets with voting booths. Markets have rallied under both parties, and markets have dropped under both parties. Sometimes stocks just have a mind of their own. In the long run, it’s all about earnings and valuation.
Complacency is viewed by some as important because events could send surprised investors heading for the exits. I’ll try to evaluate that idea with several different approaches.
The Dimensions of Complacency
A quiet market. This is a common definition of investor complacency, especially when stocks are rising. CNN Business leads their complacency story with these observations:
There is an eerie sense of calm on Wall Street heading to the end of the year. It’s the inverse of last year’s December market panic.
Stocks are at all-time highs. The CNN Business Fear & Greed Index is hovering above 90 — firmly in Extreme Greed territory — for the first time since 2017. The index, which tracks the VIX (VIX) volatility gauge and six other measures of investor sentiment, can’t go higher than 100.
But are there risks investors are ignoring?
The trade war isn’t necessarily over. Earnings estimates and valuations may be too high.
And oil prices have crept up lately while the dollar has softened, raising the potential specter of commodity inflation. Could the Federal Reserve have to (gulp) raise rates in 2020 after all?
Jeff: Market action is the aggregate of millions of individual actions. Describing markets as having goals, targets, and emotions is popular but of little analytical value. A “quiet” market could be achieved with different factions intensely pursuing opposite goals. And it has little to offer about the potential for frightened investors.
Surveys of investor sentiment.
Here is the popular survey of the American Association of Individual Investors. You can see the bullish reading of 44.10. Does it seem extremely high?
The Daily Short displays the same data as a spread between bulls and bears. Now the current level seems much more extreme. Is this the right approach to take?
David Templeton (HORAN) adds an eight-period moving average to the Bespoke approach. Does the MA seem to lead the market?
Jeff: I am a big fan of surveys when properly conducted and used for the right purpose. This one, which I occasionally cite, has several problems:
- It asks about attitude or intentions rather than describing behavior. Results are less accurate in those cases.
- The universe includes self-described investors who are part of an organization. It omits many of the people of greatest interest – the sidelined investors.
- The indicator can be measured in several different ways none of which has a clear predictive relationship to market results.
News certainly moves markets and the trade war has been one of the most closely watched stories.
Jeff: The data show moves of less than nine percent over two days in the case of the most dramatic stories. Please note that the universe is a basket of stocks determined (after the fact?) to be sensitive to trade and weighted by that sensitivity. Both the stories and the basket are selected for dramatic effect. Once again, we learn little about how investors might react to this, since the trade story typically generates a trading reaction.
Dumb money is complacent
There are many definitions of “dumb money” but it is usually ascribed to individual investors.
And of course, these investors display fear and greed at the wrong times.
Jeff: I strongly dislike approaches where the message is carried in the title terminology and the exact methods are obscure. Just as important is the lack of evidence that these are leading indicators. Finally, how does it capture the emotions of our sidelined investors?
Jesse Felder’s approach concludes that sentiment has only been this bullish on two prior occasions. He uses “the Rydex Ratio, or the measure of Rydex traders’ assets in bear funds and money market funds relative to their assets in bull funds and sector funds.” He likes the measure because it is based on real money, not opinion.
Jeff: I also like data based upon action in preference to a survey. Once again, the problem here I that we are looking at traders, not individual investors. The sideline folks we are concerned about have never heard of a Rydex fund. We cannot impute trader behavior to these investors.
But does the method provide a good predictor of the market? The second chart looks like a fuzzy coincident indicator, but you really need to do a lags and leads test on the underlying data.
Meanwhile, another group of traders, those who use S&P options, are skewed very bearish in their positions.
This is still not an indicator for individual investors, of course. It is more a response to the Felder approach. Different markets and different trader groups provide different results.
Better fact-based measures
The best sentiment measures are published in my quant corner every week.
- Compare the VIX (called the market’s fear gauge) to the actual volatility. When it is much higher there is plenty of fear reflected in the market.
- The equity risk premium compares the expected return from stocks and bonds. Since the bond return is known, a wide spread implies little confidence in expected earnings.
These indicators do not cover the sidelined investors, but do we think they are less fearful than those who are in the market? I view the fear indicated as an “underbid.”
I’ll have some additional observations in today’s Final Thought.
Quant Corner and 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, featuring the Indicator Snapshot.
Both long-term and short-term technical indicators remain neutral, and are finally showing improvement.
Recession risk remains in the “watchful” area. There is little confirmation for the risk signals, which we have been monitoring since May. Many observers who reacted to the yield-curve inversion have become less worried.
Let’s check in with Business Cycle expert Dr. Robert Dieli. Here is just one page from his excellent monthly business cycle update. (He also has a monthly analysis of the employment report and special reports as needed).
This is a great explanation of why we remain watchful on the recession front. Most “newbies” in this field reacted too much to the inversion and now to the steepening. The desire to sound smart on TV leads many non-experts to over-simplify complex subjects.
Some readers have asked how my conclusion can be bullish when technical indicators are weak. The outlook is intended for investors. For them, the technical indicators are mostly useful to guide specific entry and exit pionts. An attractive equity risk premium and modest recession odds are the keys for investors.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score”.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. With the key November reports all in, it is time for an update of their excellent Big Four summary.
The most recent forecasts for Q4 GDP range from 1.3% to 2.1%! Take your pick. (Calculated Risk).
Insight for Traders
Our weekly “Stock Exchange” series is written for traders. I try to separate this from the regular investor advice in WTWA. There is often something interesting for investors, but keep in mind that the trades described are certainly not suitable for everyone. We welcome my colleague Todd Hurlbut, Chief Investment Officer at Incline Investment Advisors, LLC. He chose this week’s topic, Intuition or Intu wishing?
The trading models are back on the job with comments about current trades. Some of them this week even looked attractive for long-term investors.
Insight for Investors
Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely
Best of the Week
If I had to recommend a single, must-read article for this week, it would be the introspective and insightful piece by The Heisenberg, where he sets out to dispel some “popular Heisenberg misconceptions.” There are several features that investment readers will find useful, although it is certainly a change of pace from my typical “best of the week.”
- Even mild, neutral analysis inspires many readers to an aggressive reaction. His examples are very interesting.
When I first started writing for public consumption, I tried presenting the bear case in forceful, sometimes bombastic terms, but that got old pretty quickly for me, even if not for some readers. There’s always a bear case and somebody as adept as I am with the digital pen can always make it convincingly, especially given my access to copious amounts of data and information.
It’s no longer clear to me whether market participants are pricing in [legitimate] concerns or pricing in an increasingly dire narrative and then using the resultant selloff to justify that same narrative in a self-feeding insanity loop.
It’s interesting how insanity becomes contagious. The underlying force that binds everything together – this process – is that fear has become the new cognitive principle.
And fear is self-reinforcing. If you spread fear, it looks like you have a deep knowledge of things. If you are calm, it is like being ignorant.
At least two analysts have discussed what happened in late 2018 in the context of fear. Kolanovic, for example, tackled it head-on. A year ago last week, he famously lamented how misinformation is disseminated to market participants, citing the “mass production” of content that mixes real and fake news with “somewhat credible, but distorted” coverage of “sell-side financial research.” He wasn’t talking about me, I can promise you that.
He then warned that “if we add to this an increased number of algorithms that trade based on posts and headlines, the impact on price action and investor psychology can be significant.”
In recent months I have occasionally quoted The Heisenberg. The work had become more relevant and useful. Now I know why.
Chuck Carnevale continues his series on the principles of valuation, this time discussing a common problem: Avoiding obvious mistakes.
Barron’s liked FedEx before the decline. Now? FedEx Stock Got Crushed After Earnings. Barron’s Says Stick With It. [Jeff – I agree. We were buyers on Friday].
Biotech? Karen Langley (WSJ) explains the factors behind the recent rally.
Blue Harbinger has more REITs on his radar: Brookfield Property (BPR) is “worth considering” and Ventas (VTR) is “attractive.”
“Davidson” (via Todd Sullivan) has some ideas for the Liquid Natural Gas sector. “Beginning in 2015 LNG Exports have grown from non-existent to 0.85Bill/mo.”
Looking for a straggler? Barron’s opines that Becton Dickinson (BDX) is ready to surpass its peers.
The Great Rotation
One objective for those of us investing in the Great Rotation is more exposure to emerging markets. Picking individual stocks in many of these countries can be a challenge. This is an occasion when an ETF might be a better choice. Seeking Alpha ETF expert Jonathan Liss interviews Perth Tolle, whose interesting background helped him create the Freedom 100 Emerging Markets ETF (FRDM). A key objective for this approach is avoiding the direct China exposure of 30-35% in cap-weighted indexes. There is inevitable indirect exposure because of China’s trade role with emerging market. The result is an approach that includes an objectively derived “freedom ranking.” So far the thesis that freedom helps economic success is proving out. Here is a key answer:
PT: So, we’re actually – we’re not just excluding countries, we’re actually also rewarding countries for being more free, so we’re promoting, you know, freedom in these countries and investing more in those cases. So, countries like Taiwan, South Korea, Chile, and Poland are getting a higher weight in the index because of their freedom levels. So, the higher the freedom level, the higher the weight, and then the lower – you know the kind of lower freedom countries are getting, but they’re not completely like abysmal so they’re not excluded, they’re still included. They get a lower weight as a result of their lower freedom scores. So, it’s all based on their freedom score. So, the freedom score is the only factor we use on country allocations.
Dividend Sensei discusses the elements of good news from recent weeks – all familiar to WTWA readers. Unlike others, he then applies the new information, writing The Best Dividend Stocks Smart Investors Can Buy Now That We Have A Trade Deal. I like his conclusions but also the process. It is a long article, providing a lot of detail. For me the key is using recent information in stock selection and maintaining a long-term time frame.
Watch out for…
New Residential (NRZ), a Levered Cluster Bomb To Be Decimated in the Next Great Recession. Blue Harbinger reports that income-hungry investors are like moths to a flame when they see the big 12.3% dividend yield.
Tesla (TSLA). Kirk Spano advises those who joined him in buying below 200 that it is Time To Start Trimming Tesla.
Boeing (BA), where Stone Fox Capital concludes: Big Cash Burn, Big Avoid.
When I speak with investors, there is always a lot of nervousness. Mostly it is just a sense that a market at new highs must be dangerous. Sometimes there is concern about the length of the bull market. I would hardly call them complacent. There are a lot of cautious bulls, but few ready to run for the hills because of the next headline.
And these are people in the market. The equity outflows and bond inflows have shown the dominant trend all year. It does not signify a dangerous level of complacency.
I hope readers appreciated the implications of The Heisenberg link (above). I once mused to Mrs. OldProf that if I approached investment blogging with a strict profit motive, I knew how to get page views, ads, and notoriety. I elaborated on the techniques, citing the success of some of the leading sources. There is much less interest in investment education and a willingness to see all sides. “But then,” she said, “you would not be yourself and you certainly wouldn’t be happy.”
Great Rotation Hint of the Week
The past week provided a contrary test. End-of-year trading seems to be at variance from the recent trend. As I have noted, this process will take a long time. Review what Bob Dieli (above) said about third-order effects. The market was slow to grasp the trade war negatives and few are even thinking about the actual positives. Most are focused on the politics.
I am about 50% invested in my themes of value, small and mid-cap, non-US markets, and trade deal beneficiaries.
Astute investors should take a close look at the differences between now and a year ago. Edward Jones has a nice summary.
Different times call for a different portfolio. Take what the market is giving you.
Some other items on my radar
I am trying to put the worries aside for the holidays. These are not the main stories, so I’m going to focus on some new ideas. But don’t call me complacent!!
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