Weighing The Week Ahead: What Is Your Course For Uncharted Waters?

Here is Eddy Elfenbein’s advice – always wise and clearly-stated. The full post is great – and he includes some stock ideas.

The first and most important thing to do is not panic. In fact, that’s so important that I’ll make it the first and the second thing to do. Remember Warren Buffett’s dictum: “Be fearful when others are greedy. Be greedy when others are fearful.” Right now, there’s a lot of fear. I don’t advocate greed, but I do support disciplined buying.

I also don’t want you to concern yourself about waiting for the absolute bottom. In retrospect, people think of “the low” as a big event that…happens. In reality, no one realizes it at the time, and it usually happens a lot faster than you think. You can be sure there will still be people predicting the next big leg down.

In 2008, a major low came on November 20. Although this wasn’t the absolute low, it was a good time to buy. At the time, people were massively freaked out. The VIX was at 80. That’s crazy, but the prices were good.

Right now, investors should focus on high-quality stocks going for discounted prices.

Quant Corner

We follow some regular featured sources and the best other quant news from the week.

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.

The Indicator Snapshot

Short-term trading conditions returned to the highest risk level. This reflects Vince’s research on the combination of factors that make successful trading difficult. It does not necessarily mean that markets will move lower, but the danger is there. When conditions are technically challenged, we watch trading positions even more closely. Each of our models has a specific exit strategy. The technical health rating may drop enough for a complete trading exit. It got close to that level again last week.

Long-term trading has also returned to the highest risk level. Those who emphasize technical analysis have emphasized the “damage” done to charts by the sustained correction. Our methods show that a clean bill of technical health will require some time.

Fundamental analysis remains strongly bullish. Earnings are great, prices are lower, and there is even less competition from bonds. We reduce fundamental positions (as we did in 2011) when we get a warning from the recession or financial stress indicators, not merely as a reaction to technical signals.

The C-Score method started showing higher recession probabilities in 2006. In early 2007 it showed that a recession was likely within the next nine months. The yield curve is part of the method, but it also includes indications for the likelihood of Fed action. It is an improvement over the yield curve by itself.

The St. Louis Financial Stress Index is not about recessions. It includes eighteen factors including various interest rates, credit spreads, the VIX, and similar factors. This research exhibits the highest statistical standards. Here is the historical chart and the suggestions for interpretation.

How to Interpret the Index:
The average value of the index, which begins in late 1993, is designed to be zero. Thus, zero is viewed as representing normal financial market conditions. Values below zero suggest below-average financial market stress, while values above zero suggest above-average financial market stress.

This leads me to a “neutral” overall outlook. It might be better stated as bullish for long-term investors and dangerous for short-term traders.

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.

RecessionAlert: Strong quantitative indicators for both economic and market analysis.

Georg Vrba: Business cycle indicator and market timing tools. None of Georg’s indicators signal recession. Here is the latest update on his BCI indicator.

Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis. It is time for another look at the Big Four.

A recession starts when these indicators not only “roll over,” but also decline significantly from the peak. That is the official NBER dating process.

Insight for Traders

Check out our weekly “Stock Exchange”. We combine links to important posts about trading, themes of current interest, and ideas from our trading models. This week we questioned whether technical damage was a contributor to market declines. As usual, we discussed some recent picks from our trading models and highlighted advice from trading experts. Our ringleader and editor, Blue Harbinger, provided fundamental counterpoint for the models, all of which are technically-based. The models have a much different approach to volatile markets than that which I recommend for investors.

Final Thought

Looking at the data instead of stock prices is such a challenge. What do you suppose would happen if we kept a batch of pundits in isolation, showing them only the news for the day? We then ask what they think the market did. My guess is many more sheepish faces and much less smugness.

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