The Week Ahead: One Person’s Risk Is Another’s Opportunity

A recurring theme at “A Dash” is the question of time frames.  Let me posit three different investors:

• The Trader has a three-week time horizon.  He wants action and actively tries to time the market.
• The Investor has a multi-year horizon.  Since he is not poised to sell a stock each day, he embraces the downturns in Warren Buffett fashion:

This is the one thing I can never understand. To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the “Hallelujah Chorus” in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying–except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.

• The Asset Allocator does some market timing.  This is not the World Series of Poker, so you do not have to go “all-in.”  Asset allocation is very personal and very important.  It is important to view market commentary through the lens of one’s own needs and situation.

The current story for these three hypothetical investors is quite different.  Let me take a deeper look.

Last Week’s Action

The first part of the week broke the recent pattern of higher opens and later selling.  It did not last for long.  Here is the weekly review.

The Good.  Corporate earnings continue to surprise positively.  There are many skeptics about forward earnings, often taking an inconsistent position.  When companies beat expectations, they say the bar was low.  When we look ahead to forward earnings, they say that the estimates are inflated.  It is something to think about, especially since both recorded and forward earnings have been looking great.

Brian Gilmartin follows earnings trends closely.  His approach is client-oriented and unbiased.  Here is his recent take (from TheStreet.com’s RealMoney):

Something has to give here: either the economy will have to slow markedly very shortly, or it appears the general market indices are undervalued relative to their expected earnings growth in 2010. (I personally expected q3 and q4 ‘10 earnings growth to be revised lower, i.e. under 20% after we started seeing q4 ‘09 earnings. Not the case at all. )

Economic data were very solid.  The ISM report handily beat expectations, consistent with very strong economic growth.  The employment report was encouraging on many fronts.  The payroll number was within the error range of our prediction of a slight gain.  Meanwhile, the unemployment rate declined.  There is a lot of negative spin on this, as we predicted would happen, but I see it as a slight positive.  Check out this nice summary with “four pictures” by Menzie Chinn.  He does a nice job of explaining the census adjustments, a target for various biased pundits of the bearish persuasion.  (I wonder what these guys would do if they had a real job.  You get new and more accurate data.  What should you do?  They have never had that responsibility so they are free to bloviate.)

The Bad. Initial jobless claims ticked higher again.  My concern from last week continues.  I do not think that job creation has really kicked in.  A sustained recovery requires real job growth.  This was the most disturbing economic data of the week, and the report was not part of the survey period for the monthly employment situation report.  In fact, jobless claims have deteriorated since that period.

ISM services was also light.

The Ugly. Thursday!  And most of Friday.  Worries over crises in Europe, the slight downtick in initial claims, and the strengthening dollar provided the spark.  The tinder was the technical situation.

Charles Kirk started a new series where he does a video with charts and narrative.  He says that it is time to play defense. I enjoyed the first installment and I hope he continues the series.  Charles is very responsive to his members, who pay a very modest fee for a great service.

Barry Ritholtz captures the day nicely in Pigs Won’t Fly.  He has a good technical take, still willing to see a bounce.

Muckdog is a great reality check.  Over the years I have found his analysis to be a sensible middle ground, while reflecting widely-shared concerns.  (I also took his contrarian advice on the Saints).  Here is his take:

I don’t want to jump on the doomsday bandwagon, which many do after the market goes down a few percent.  But, the deficits at the federal, state and local levels seem to be a systemic problem.

The Bespoke Investment guys have another great chart which you should visit their site to see. The point is that we are as oversold as at the peak of the financial crisis.

The Week Ahead

This is a light week on the economic front.  Initial jobless claims, retail sales, and Michigan sentiment all come near the end of the week.  I expect technical considerations and the dollar to be much more important.

The sharp rebound on Friday was attributed by some to a rumor about a bailout for a European nation.  I dismiss the idea that it was the DC snowstorm, even though we know the market loves political gridlock.

The real answer:  Slight selling in the dollar.  No one understands the causation, but all are watching it.

Our Trading Forecast

Our own indicators (see our regular ETF updates for an explanation) have shifted to bearish, and that was our vote in the Ticker Sense Blogger Sentiment Poll. Here is what we see:

• 25% (down from 67%) of our ETF’s have positive ratings.  This is very weak.
• The median strength is -15 (down from +6), very negative.
• 75%  (up from 35%) of the sectors are in the “penalty box,” showing much higher risk than in recent weeks.
• Our Index Package has a negative rating.  We own SH and DOG, the inverse ETF’s for the S&P 500 and the DJIA.

A Helpful Insight

Weeks like this create stress and confusion for investors.  I suggest a simple solution.  I have three approaches, one for each of the hypothetical investors at the start of this article.  You can do the same thing.

Decide on your initial asset allocation.  Do some long-term stock picking, buying like Buffett when you get the chance.  If your picks are good, this will work, as it does for us.  Use a short-term trading strategy (like our TCA-ETF approach) to do “fast adjustments.”  Finally, have an overall asset allocation that makes sure that you are not wrong for too long.

This combination can have nice returns while smoothing volatility.