The economic calendar is one of the lightest we will see in 2020, and we have a holiday-shortened week. Economic data will not be the main story. The news will be filled with Impeachment updates, but that is not a focal point for investors. For us there are 144 earnings reports from S&P 500 stocks. It will be a case of:

All Eyes on Earnings

Last Week Recap

In my last installment of WTWA, I asked whether it was yet time to worry about inflation. It has been so tame that most do not see the risk. I said that I was probably still early in this worry, and so it was. I also failed to reach much of my audience. Despite my rationale that understanding the Fed helps your investing more than railing against the government’s inflation numbers, many remain unconvinced. At least I tried!

Personal Note

Mrs. OldProf asked me how this picture of my box of cords got in the WSJ. She believes that I could have done more weeding before our recent move. (I’m not allowed to talk about her “mystery” stuff). She doesn’t know that I have three boxes like this (I think – might be more).

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 Jill Mislinski’s weekly update, which combines several key features in an easy-to-read picture.

The market gained 2.0% for the week. The trading range was 1.9%, on an intra-week basis. You can monitor volatility, implied volatility, and historical comparisons in my weekly Indicator Snapshot in the Quant Corner below.

Noteworthy

Statista shares the most read Wikipedia Articles of 2019. I’m sure there is a lesson in this.

The News

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. This week the indications are positive in all three time frames. NDD has been watching for signs that manufacturing weakness might have spread to consumers. His conclusion is a bit more upbeat:

As of this week, there is little sign that the weakness in the producer sector has spread out to affect consumers. The conclusion that this remains a passing slowdown vs. a recession remains most likely.

Fans of technical analysis might compare this with the improvement in market health in the Quant Corner (below).

NDD’s conclusion has some support from Bloomberg’s read on consumers.

The Good

• Mortgage applications were very strong. The start is even better than last year’s excellent performance.

• Core CPI increased only 0.1% in December versus expectations of 0.2%. As I explained in the last WTWA, low core inflation allows the Fed to remain on the sidelines. There are better indicators of economic growth.
• Core PPI increased only 0.1% in December versus expectations of 0.2%.

• Retail sales for December increased 0.3%, in line with expectations, but November was revised from 0.2% to 0.3%. The ex-auto report showed a gain of 0.7% versus an expected 0.5%. (MarketWatch).
• Initial jobless claims surprised by recording only 204K last week. This beat expectations of 217K and the prior week’s 214K.

• The JOLTS report for November confirms the expansionary labor market. The quits rate, an indication of employee confidence, was 2.3%. The ratio of unemployed workers to job openings declined slightly but remained at historically low levels under 1.0. The Beveridge Curve remains stronger than at the start of the expansion in the 2000’s. (Washington Center for Equitable Growth). The superficial treatments of this report just mention the number of job openings. The real purpose in value is the insight into labor market structure. Calculated Risk also pushes back on the common superficial interpretations.

  So, for the twenty-first consecutive month, there were more job openings than people unemployed. Also note that the number of job openings has exceeded the number of hires since January 2015 (almost 5 years).

• Housing starts for December were 1608K (SAAR), far surpassing the expected 1380K and November’s (upwardly revised) 1375K. Calculated Risk provides the analysis and a possible explanation. (Emphasis in the original).

  These were blow out numbers! This was the highest level for starts since December 2006 (end of the bubble). However, the weather was very nice in December, and the weather probably had a significant impact on the seasonally adjusted housing starts number. The winter months of December and January have the largest seasonal factors, so nice weather can really have an impact. Note that Permits were more inline with expectations (still solid).

  Single family starts were up 29.6% year-over-year, and multi-family starts were up 74.6% YoY.

The Bad

• NFIB small business optimism for December registered 102.7, down from the prior 104.7. It remains in a historically high range. David Templeton (of HORAN Capital Advisors) notes that it is one of the highest readings in the 46-year history of the index. There is also a decline in the number of respondents describing the “Cost of Labor” as the single most important problem. Diana Olick notes that the optimism slipped slightly but is still high.

• The NAHB Housing Market Index for January was 75. While this was a slight beat of expectations, it was lower than December’s 76. Bespoke Investment Group highlights the positive.

• Industrial production in December declined 0.3% versus expectations of a 0.1% gain. November was also revised lower, from the reported 1.1% gain to 0.8%.

The Ugly

Puerto Rican rescue supplies sitting in a warehouse? For years? “Explanations” are being offered and we do not yet know if this was mismanagement or corruption. It is bad enough to suffer through these natural disasters, but those cannot be controlled. This could be. (CBS).

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 Calendar

The economic calendar is light and the week is holiday-shortened. The big news will come from corporate earnings reports. 88 companies in the S&P 500 have reported so far, and another 130 will do so this week.

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Next Week’s Theme

As always, earnings season provides validation – or refutation – of economic data and market prices. This week we have:

All eyes on earnings.

Background

Like any complex story, earnings reports present a great opportunity for pundits and for those on a mission. Everything can seem great in a report, but a few cautious words in the conference call can change everything. Even if a company’s report is spotless, a subsequent decline is interpreted as the news that was already “baked in.” It would be interesting if those who act so smart after the reports had to tell us what is “baked in” before the announcements!

What to Watch

Investors who are willing to do some work can learn a lot during earnings season. Here are some ideas that can guide your research.

Forward Earnings Lead Actual Earnings

Markets act on expectations of future outcomes, not history. Dr. Ed Yardeni has been tracking forward earnings for decades. His site provides an impressive analysis of economic series and stock prices that are strongly correlated with forward earnings. Here is one important example.

Stock Prices and Valuation

Forward P/E is an excellent measure of valuation. The valuation measures in the table below have mostly worked to keep investors out of the markets during the entire rally. The last one, EY Spread, is the earnings yield minus the lowest investment grade bond. By this measure, stocks are significantly undervalued.

Watch Sector Results Through the Earnings Season

This provides more information about the economy and underlying investment trends. This chart shows the long-term history of various sectors versus the year-by-year results.

A great source for this is John Butters at FactSet. He regularly provides updates on overall results as well as the sector analysis. I’ll start showing the charts next week when there is more data.

Look at Revenue as Well as Earnings

I am not as suspicious as those on my “reliably bearish commentators” Twitter list, but we all know that some companies “manage” their earnings. Looking at revenues and cash flow provides a good check on this possibility. John Butters also provides this important data.

Watch Changes in Forward Estimates

Since forward estimates are so helpful, changes are an early warning system. For many years Brian Gilmartin has been a leader on this subject. In this post he explains some current revisions and a possible pattern in the first quarter of each year. Instead of trying to do some statistical analysis of a handful of data points, he takes a closer look at each year. Here is his conclusion, but read the full post to understand the method:

My own opinion on the general bearishness of analysts regarding forward prospects is that it’s partly a hangover from 2008, the worst recession in the post WW II era, but also management’s have little incentive to be aggressive, which is the complete opposite of the late 1990’s.

This may surprise those who believe that analysts are always too bullish. Since the bar is always low at the time of the report, they had to turn pessimistic at some point! Brian’s hypothesis explains why things often look weak at the start of a year and then firm up.

Read the Transcripts

Not so long ago anyone wanting to hear a company’s conference call would need to learn the number and listen to the entire presentation. If you want to feed your algorithm or trade on “breaking news” that is still necessary.

For many investor purposes it is enough to read the transcript after the fact.

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, but are now improving. Last week’s trading was a tonic for nervous technical indicators.

The C-score remains in a zone which suggests that we watch for confirming data. Like others, we don’t see much of that. Most sources have lowered recession odds, and some have moved recession chances completely out of 2020. Why has the C-Score fallen? The potential for inflation. So far, so good on that front, but it is important to keep the Fed out of play while we start to enjoy reduced trade war effects.

The Featured Sources:

Bob Dieli: Business cycle analysis via the “C Score”.

Georg Vrba: Business cycle indicator and market timing tools. The most recent update of Georg’s business cycle index does not signal recession.

Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.

Guest Sources

This is an important chart from JP Morgan’s excellent Guide to the Markets. Keep it handy for when someone tells you about the aging bull market.

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 Trent Hamm’s How to Turn What You Read into Financial Action. (HT/Abnormal Returns). We are all overwhelmed with ideas, making it a challenge to implement those that are important. This post may seem simple in principle – and it is. That does not make it less important. The author raises three questions:

1. Is there anything in this article that feels like it could actually improve my life in a way that I seriously want?
2. Is the proposed change a realistic one for my life situation?
3. What single action could you take that would start you on the right path?

He provides a number of great examples, including a frugal Valentine’s Day. (That won’t be on my list!)

Make it a point that, when you find an article that describes something really powerful and meaningful to do, you actually translate that into one single meaningful action. Do just one thing. Don’t try to do it all – that’s overwhelming. Break it down to just one step, do that one step, then ask yourself tomorrow how you feel about it.

That’s how real change begins. It doesn’t come from reading an article and forgetting about it. It doesn’t come from trying to change everything all at once. It comes from that one meaningful action.

He challenges readers to take something from his article and do it. It provides proof of concept. I might offer the same challenge to WTWA readers, since I have some very specific suggestions this week.

And as for my own challenge —- where is that box of old cords?

Stock Ideas

Lyn Alden Schwartzer’s 2020 preview has been published. It is packed with facts and important strategic ideas. I recommend reading it carefully. I am answering many of the same questions, so it will be fun to compare!

Chuck Carnevale explains that Value Investing Is A Long-Term Strategy And Should Be Judged Accordingly. As always, he illustrates his analysis with great examples. Readers will, as usual, get both a lesson and some stock ideas.

Oil services? Schlumberger (SLB): A Dominant Oil Franchise
says Michael A. Gayed. He mentions that earnings will be out next week. Read the full analysis carefully.

Stone Fox Capital analyzes BoAML’s call of Citigroup as the “pick of the decade.” It is a good analysis of an interesting call, “an insanely cheap stock” while the “whole money center bank sector remains exceptionally cheap.”

Kirk Spano has another report from CES 2020: EVs Could Dominate New Car Sales By 2030. His article includes several key themes, including when to expect fully autonomous vehicles and which companies are poised to benefit. This discussion of sales trends and cost of ownership is especially helpful.

Pharma and biotech? Executives at the JP Morgan Healthcare Conference were not worried about the political rhetoric (Barron’s). “When asked, many pharmaceutical and biotech executives offer the same answer: Whatever happens, our company’s drugs are important enough that we’ll get paid fairly for them.”

The Great Rotation

Here is an update on the trade war impact on agricultural exports. (EconoFact). Read the full article for an explanation of the retaliatory tariffs and other indirect effects. Even the modest Phase One program unwinds some of the negative effects and begins the process toward more.

Emerging Markets Could Be Poised to Outperform U.S. Stocks for a Very Long Time writes Andrew Addison. His argument is technical, illustrated by this chart:

Watch out for

• High yield debt (junk bonds). This chart shows the yield to worst (that means the soonest time the bond could be called away to your disadvantage). You are getting stock-like yields with a lot less upside.

• Excessively high REIT yields. Blinded By The Dividend-Paying Light: Beware Of Washington Prime’s ‘Sucker Yield’
  writes Brad Thomas about WPG. What about a dividend yield of 26.74%?

  Well let me put it bluntly, it’s a sucker yield.

  Frankly, there’s no excuse for it.

  There are times when a dividend-paying company – particularly a REIT like Washington Prime is – can offer a 7% yield in a safe manner. There are times when a REIT can offer an 8% or even 9% yield without breaking the bank.

  But I can’t think of a single example of a dividend-paying company – REIT or otherwise – that could sustain something over 20% for too long.

Final Thought

Some of the easy money in the market has been made. The multiple of forward earnings at 18.8 is much more reasonable than last year’s. It can move even higher (and often does with rates this low) but it will require continued confidence in the economy. That translates into confidence in earnings expectations.

I find backward-looking earnings analysis far less valuable than forward earnings. Oftentimes those using past earnings do so only because they do not understand how to forecast.

Sure, it is important to normalize earnings growth to reflect the business cycle. I do this in every stock I purchase, using the excellent FASTgraphs tool. What is the difference in my approach?

1. I do not use data from the nineteenth century. Or even most of the 20^th century. An adjustment should reflect the relevant factors, not using all of the data merely because you have it.
2. I consider interest rates as part of the process. I demand a much lower P/E ratio when the yield from bonds is attractive. The expected inflation rate is relevant for both.

These concepts are more widely accepted after a ten-year rally, but when I first started writing they were controversial. Many contended that the proper P/E for stocks was fixed at about 16x trailing earnings. Using forward earnings was something that “bullish analysts” did. People did not accept the fact that this was the investor’s choice. Critics continue to disparage the concept of seeking the most rewarding investment by the term “TINA.” There is no alternative. That is just a sassy way of saying what some of us pointed out a decade ago.

An idea for beating the markets is illustrated below in this mystery chart.

Great Rotation Hint of the Week

If you have been following my weekly hints, you are building a portfolio that will take advantage of the Great Rotation. I have been quite frank about my method. If you do similar homework, you’ll find some really attractive stocks. This earnings season I am looking for companies that complain about effects of the trade war. I do not care if the earnings were weak; I want to know the reason. A closer look will allow me to evaluate how much the Phase One deal will help.

For my final advice this week I am tempted to say, “Buy low and sell high.” I do not mean to be glib, but that is the choice facing investors. It will not be enough to play along with what worked last year. I’ll have more on this theme in my Preview for 2020 – soon to be released.

[This is a time of great risk and great opportunity – a bad place to make a big mistake. Is your portfolio ready for the Great Rotation? Are you overloaded with risky, overpriced stocks? If you are unsure, contact me for my brief paper on Four Signs of Portfolio Trouble and also the one about Market Highs..

Some other items on my radar

• Inflation remains a concern, despite the recent reports. Rental charges are moving up and the labor market remains tight.
• Business investment. If uncertainty was reduced, businesses could act more decisively. New equipment and plants would foster productivity and economic growth.

And then we have the “Mystery Chart.” The underlying ETN is CAPE, a method based on Dr. Shiller’s work. Rather than using the ratio to time the market, the managers compare the CAPE for various sectors to historical norms (not going back to 1871). They do not get out of the market. They buy the cheapest and exit when the sector becomes more expensive.