We have a light economic calendar and a holiday-shortened week. The NFIB small business report is interesting, as is the continuing information on jobless claims.

There will be plenty of political news of course, but market attention will be focused on this novel idea that markets can move downward. Maybe even a lot in a single day. Many unconvincing reasons were offered for Thursday’s sell-off, so there is plenty of room for the punditry to continue the debate. Most will be asking: Is this the start of something big?

Last Week Recap

In my last installment of WTWA, I considered several aspects of the Great Reopening, wondering if it was risky business and how we could tell. The jury is still out for most of this story since there is a lag in getting results about new pandemic hot spots.

We do have some returns from college campuses, and they are not promising.

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 Investing.com. A visit to the site will let you experiment with various indicators and see what each of the news callouts represents.

The market declined 2.3% on the week with a trading range of 7.1%. This represented a significant increase in both actual volatility as well as the VIX (see Indicator Snapshot below).

The weekly sector chart shows the sources of the action.

Trends are tricky to spot in this interesting chart. Energy continues on its own path, perhaps because of weather. Financials and industrials have leveled off. Materials and semiconductors are weakening. Utilities and consumer staples are showing strength. With the market near new highs, it is important to remember that these are relative performance indications, not absolute measures. (The sector names are here. The Bloomberg symbols add “S5” at the start of the name). I have invited our team member who tracks the data to provide a comment in the near future.

Noteworthy

With increasing attention to the question of investing abroad, it helps to consider all the risks. The Visual Capitalist shows that some places are riskier than others.

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 more important than ever. As we look for turning points and the sustainability of the rebound, these are the earliest clues. His latest update shows all three of his time frames in positive territory, despite the end of federal emergency unemployment benefits. NDD remains concerned about the coronavirus and reactions at all levels of government.

The Good

• ISM Manufacturing for August was 56%, beating estimates of 54.5 and July’s 54.2.
• Light vehicle sales for August reached 15.19M (SAAR), up 4.6% from July, but still down 11% year-over year. (Calculated Risk)

• ISM Non-Manufacturing for August was 56.9%, lower than July’s 58.1% but beating expectations of 56.7.
• Initial jobless claims were 881K, beating expectations for 915K and the prior week’s 1.011M. As I warned last week, many sources ignored the (needed) change in seasonal adjustment methods. This means that the comparison with prior weeks is not valid. Calculated Risk covers this issue thoroughly. I will run the regular chart, but please take note of the seasonal adjustment caveat.

• Continuing claims were 13.254M, lower than the prior week’s 14.492M. Continuing claims are reported a week after the initial claims.

• Rail traffic continues the rebound from pandemic lows. (Steven Hansen, GEI).
• The unemployment rate for August declined to 8.4%, much better than expectations of 9.8% and July’s 10.2%.
• Help for vaccine confidence. Industry rivals will release a joint statement to reassure the public.

A draft of the joint statement, still being finalized by companies including Pfizer Inc. PFE, -0.11%, Johnson & Johnson JNJ, -0.64% and Moderna Inc. MRNA, -3.45% and reviewed by the Wall Street Journal, commits to making the safety and well-being of vaccinated people the companies’ priority. The vaccine makers would also pledge to adhere to high scientific and ethical standards in the conduct of clinical studies and in the manufacturing processes.

The companies might issue the pledge as soon as early next week, according to two people familiar with the matter. The statement would join a growing number of public assurances by industry executives that they aren’t cutting corners in their rapid testing and manufacturing of the vaccines.

The Bad

• Construction spending for July increased 0.1%, beating June’s upwardly revised -0.5% but worse than expectations of 1.0%.

• Fed Beige Book for the September meeting. September 2020 Beige Book: Modest Improvement With Continuing Uncertainty includes the key observations as well as a guide to key terminology often used at different points of the business cycle. As we look ahead to the next meeting, it is wise to check in with Fed-watcher Tim Duy. So many armchair Fed analysts opined about the new Fed direction. Tim “tells it like it is:”

Bottom Line: It has become clearer that the Fed’s updated strategy, while important, really just formalizes the direction the Fed was already taking. What it does not do is create new constraints for the Fed; I think we should all come to terms with the reality that this is not really “average inflation targeting” even if we will have to keep calling it by that name. Watch the data flow and just at least be open to the possibility that there are upside risks to the outlook.

• Mortgage applications declined 2.0%. This was, however, better than the prior week’s decline of 6.5% and the series remains strong compared to recent years.

• ADP private payroll change for August was 428K, beating July’s 212K, but lower than expectations of 1210K. My friend Mish highlights ADP methods and their misguided effort to mimic the BLS methods. I agree. Readers might enjoy my post from 2012 where I used a coffee bean guessing contest to illustrate the problem. It would be much, much better to have an independent estimate of job growth relying on a different method.
• Hotel occupancy decreased to 48.2%, down 27.75 year over year. (Calculated Risk).
• Nonfarm Payrolls for August grew by a net of 1.371M, a touch lower than estimates of 1400K and worse than July’s 1.743M
• Nonfarm Private Payrolls grew by a net of 1.027M, significantly lower than the expected 1.335M and July’s (upwardly revised) 1.481M. I question the pandemic results, based upon inherent characteristics of the BLS methods. My latest post on this topic is the most important thing for investors to read. Nonfarm Payroll Response Rate Warning Continues — 7 Million Jobs Too High? The implication is that the economy is worse than most believe on this key indicator, without attention from policymakers. I am not going to publish a misleading chart, but I will note that the prevailing viewpoint is that the rate of increase has slowed.

The Ugly

Thursday impact on large and leveraged positions. Many new traders seek action, and find it by using weekly options, leveraged ETFs, and position sizes determined by optimism rather than risk. Thursday illustrated the result. Day Trader Options Frenzy Turns Ugly in $730 Billion Nasdaq Rout. Some of the weekly option positions had one-day losses of 80-90%.

While it’s never hard to pick out staggering losses in options when markets tumble, and plenty of examples exist of well-timed puts, today’s losses were particularly harrowing for the longs. A call with a $125 strike price on Apple Inc. shares, expiring tomorrow, plunged 89% as shares sank 8% to $121. A bullish wager for Tesla Inc. to reach $500 by Friday’s expiry lost 90% as the stock dropped 9% to $407. And a call on Zoom Video Communications Inc. with a strike price of $420 became essentially worthless as shares hit $381.

The Calendar

We have a modest economic calendar in a holiday-shortened week. I doubt that any report will have a significant market impact. I am interested in the NFIB index and the jobless claim information. I do not expect the CPI to be a big factor in the near future. The JOLTs report will get attention, but it is “old news.”

We will also see low attendance and lower volumes as market participants gradually return to work.

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

Next Week’s Theme

When there is little economic news, the media and punditry must fill the vacuum. Political news will intrude on the financial sector as the election enters the home stretch.

More attractive is the market action itself. Pundits love this since everyone can have an opinion – all equal! The end-of-week trading will be the hot topic, especially if there is another tech stock decline early in the week. Expect observers to be asking: Is this the start of something big?

Background

As is the case so often, most see last week’s action through the prism of their own posture and investment positions.

James Picerno tees up the question, in Risk Bites Back.

What is clear is the S&P 500 Index took a beating in the final two trading days of this week, although it managed to claw back some of the losses in the final hours of trading. By Friday’s close (Sep. 4), this benchmark was down 4.5% from Wednesday’s record high and off 2.3% for the week—the first weekly decline for the S&P since mid-July.

All in all, not too bad when you consider that US stocks have been rising furiously for months. The question is whether something’s finally snapped? While we ponder the possibilities, let’s check in with our risk-management systems and how our proprietary portfolios are holding up in the wake of the latest run of market volatility.

I will describe the key viewpoints, with an emphasis on those I find most valuable.

Analysis

There are optimists and extreme pessimists, of course. Some see a divergence in prospects between a handful of companies and the rest of the field. I will provide a guide for the long-term investor.

Best Case

Expect to hear these phrases:

• Healthy market correction;
• Normal pull back in the new bull market;
• Selling caused by unusual factors – not meaningful to general trends.

Let us consider the last in more detail. Many observers attributed Thursday’s result to “short gamma hedging.” I did not see a clear explanation of this and certainly nothing that was convincing. I have traded “gamma” for more than 30 years. You cannot hedge it directly with stock positions, as most of the articles claim. Traders hedge “delta,” which is the move in option price given a move in stocks. Gamma is the change in delta for a given stock move. It is a second derivative. To hedge it you need to own a position that provides this second derivative effect. Buying or selling stocks will not do that, although you can find that your delta balancing is not accurate.

It is true that option sellers who are short gamma may find themselves on the wrong side of moves – either up or down. This is going to be a normal condition of markets where many want to speculate in weekly options on volatile stocks.

Does this mean that last week was a “one off” situation? Given what I have said, you be the judge.

Worst Case

This is the beginning of the end. Key phrases:

• An overvalued market eventually sells off;
• The current market is a bubble;
• This is reminiscent of 1927 (or 2000, or 2008, or the end of 2018, or earlier this year).

None of these self-serving summaries is helpful.

A Divided Market

A more intriguing alternative is the concept of a divided market. Some are calling this a “K-recovery.”

To appreciate this, it is important to consider the divergent paths. Two of my favorite sources provide great insight on this topic.

Dr. D. Valuation guru Aswath Damodaran rips away the narratives about stock splits, index inclusion and other pundit comments.

After big market movements, we are eager to look for explanations, fundamental reasons why a stock or stocks collectively moved on that day, but the reality is that a great deal of the price movement on a day-to-day basis has nothing to do with earnings, cash flows or risk. On August 31, this reality was brought home by two events, neither with a strong connection to fundamentals, that represented the news of the day and contributed to price movements.

He acknowledges that market behavior imputes significance even if it does not seem rational. This is a result of different concepts and forces.

The discussion is great, and is important for investors to read, probably twice. That said, I will proceed with the next chart.

He proceeds to a detailed examination of the purported causes, including a video and a conclusion that will sound familiar to regular WTWA readers:

At the risk of sounding cynical, much of the commentary (including mine) that you read or hear on why stocks move is more post-mortem than analysis, an attempt to provide a rational veneer to a process where human beings move prices, sometimes for good reasons, and sometimes not. 

Chuck Carnevale states his conclusion that we are in a bifurcated market. Readers know that I agree, having written on this subject almost a month ago. Chuck takes the argument to a new level, comparing high-profile FAANG names with reasonable alternative choices. The result is an echo of the Prof. Damodaran analysis of sentiment and value but using specific examples. In his classic style he does a deep dive featuring his excellent tools before reaching a balanced conclusion:

I want it to be clear that I consider Apple, Microsoft, and Visa better companies than any of the competitors that I contrasted them against. Moreover, I fully acknowledge and appreciate the incredible rates of return that these three blue-chip technology giants have produced in recent years. In other words, I am not questioning the quality of any of these companies nor am I questioning their long-term opportunity as operating businesses. However, what I am questioning is the extremely high valuations that Mr. Market is currently valuing each of them. Common sense and 5^th grade mathematics suggest that the fundamentals (precisely earnings and cash flows) do not offer yields that would make these attractive investments going forward. The companies are great, it is only the valuations that I challenge.

Readers might enjoy looking at the alternative choices and asking which is a better fit for personal portfolios.

I have a few additional observations in today’s Final Thought.

Ideas for Investors

I have switched the investor section to a separate post. I hope to run it nearly every week, calling it Investing for the Long Term. In the last installment I highlighted some current ideas using the background of my Great Reset project. I feature many of the same authors I have featured for years. The difference is that I make a more extensive comment on each idea and place it somewhere within this matrix.

My objective is to provide an additional slant on ideas that seem attractive. My hope is that my favorite authors will start to consider these criteria.

As promised, the latest edition releases the information from our most recent “Wisdom of Crowds” survey. It is crucial information about what to expect about the pace of the economic rebound. So far, the results are presaging other polls on similar topics.

Next up – I am considering adding REITs to the analysis.

A Personal Favor

Please also consider joining the Great Reset group. This drives my own investment analysis, and (I hope) inspires others. You will get updates about what is being studied and can be part of the process. There is no charge and no obligation, but I hope you will join in my Wisdom of Crowds surveys. I need more wise participants! The results of our team effort will be published on a regular basis, so you will be joining me in contributing to a greater good.

There is now a members-only portal with links to each of the nine categories. That will be the home for the results of our stock research and discussions. I have created a resource page where you can join my Great Reset group.

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.

For a description of these sources, check here.

The technical indicators reacted to the decline in market strength, partly because they were already pushing against key levels. My overall rating of “Bearish” is based on expectations for long-term investors. My key risk avoidance method is lightening up positions when I expect a recession. Hello? That is where we are. It is not a time for aggressive action by long-term investors.

The C-Score remains at levels never before seen. It is combining the sharp economic rebound with pandemic effects. When we are able to separate the two, a current mission of Dr. Dieli, it will provide more guidance on the timing and extent of the recovery.

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. This week Brian also takes note of the improvement in corporate credit spreads.

David Moenning: Developer and “keeper” of the Indicator Wall.

Georg Vrba: Business cycle indicator and market timing tools.

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

Guest Commentary

Prof. Menzie Chinn provides his look at the Big Four indicators – improving but well off the highs.

Final Thought

I do not know if last week implies an immediate market decline, and neither does anyone else. It does show that a rapid adjustment in pricing can occur in the most highly valued stocks. I continue to prefer the relative safety of stocks with better value. These can be growth stocks, but they must be “growth at a reasonable price” (GARP).

I am increasingly concerned about the uncritical acceptance of data by economists and journalists alike. My guess is that most of them have never done a survey or a seasonal adjustment. These are the key elements at the moment, and experts are needed. It is tempting for experts to expand their “happy zone.”

A Societal Divide

Because I am trying to write about what is currently most important, I considered a theme of tears in the social fabric for this week’s post. Choosing a theme that pulls together the key data and events, while hitting the most important questions, is the most challenging part about writing WTWA. After spending a few hours on the idea, I gave up – at least for now. There are plenty of sources concerned about the rending of the social fabric, but they have diametrically opposed viewpoints! I guess that might be an illustration of the problem.

Here are two (of many) concerns I have – both generational.

• Problems for the younger demographics. They are being handed plenty of debt, an aging infrastructure, a planet facing environmental challenges, and the challenge of meeting health care costs.

• Problems for the older folks.
  • Never did I think that society would balance lives against dollars by asking whether someone died exclusively from COVID. Deaths involve many factors and many (most) people have one or more of the co-morbidity factors. They were in the process of living quality lives that might have lasted for many years without the pandemic. Menzie Chinn provides data on the “excess death” analysis.

• • The threats to Social Security and Medicare. I have always been reassuring on the topic of periodic fixes to the Social Security and Medicare programs. They are popular among older citizens, of course, but also with families who are relieved of burdens they could not otherwise afford. The current pace of deficit spending and payroll tax receipts has moved the trust fund insolvency date to 11 years, instead of 15 (MarketWatch).

Feel free to highlight your own divisive issues. There are so many, and so often trivial matters that spark disagreement. Investors of all ages should think about these problems and how they affect their own planning.

So many solutions require leadership and social cooperation. Sadly, both are in short supply.

I’m more worried about

• The Presidential election. I am concerned about a close election where the result is not accepted by the loser. David Brooks (a Republican) lays out the scenario for the President to reject the result. Do not expect concessions from Biden if the result is close. The market shares this concern, as Michael P. Regain explains in U.S. Election Priced as Worst Event Risk in VIX Futures History.
• A government shutdown. Supposedly the fiscal stimulus chances are lower after the employment report, regarded as “good enough” by many in Congress. But there is an agreement on a “clean” continuing budget resolution. I am still worried that one side or the other will balk at this if there is an apparent path to blaming the other. I am watching this closely. (MarketWatch)

I’m less worried about

• A September effect. These calendar theories suggest very small differences when compared to the current market conditions and upcoming events. Paul Schatz comments:

As the calendar has turned to September, let’s not forget all of the pundits who incorrectly warned about August being such a tough month. While there is nothing wrong with being wrong (I do it every day), there is a lot wrong when you are lazy and do not do your homework. Those who painted August with a broad brush just recited some stat they saw on Twitter.

• China dumping U.S. Treasuries. The Reuters headline uses the “D” word but the text describes a gradual cut. There is plenty of appetite for U.S. bonds and an active arbitrage with European countries. This is very low on my worry list.