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Indicator Update 9/25/11

Once again I am offering the “preview” segment of my weekly market commentary.  If you want the review of last week and the intro, you can check out my blog.

This segment is selected to highlight points for the Wall Street All-Stars audience — the most important things to watch for next week and a summary of key data.  The key point this week are twofold:  The near-term still looks bad, but the recession scare is overblown.

The Indicator Snapshot

It is important to keep the weekly news in perspective.  My weekly indicator snapshot includes important summary indicators:

As I have often noted in the past, the ECRI and the SLFSI report with a one-week lag.  This means that the reported values do not include last week’s market action.  In my research, I take account of this lag.  In my daily monitoring of the market I look at the underlying elements in the SLFSI.  I cannot do this with reliability for the ECRI since the indicators are secret.  The SLFSI will increase next week, but not to the level that would trigger the “risk alarm.”

There will soon be at least one new indicator, and the current choices are under review.  Meanwhile, the ECRI has a “long leading” series that is available only to subscribers, which they refer to in media appearances.

Indicator Snapshot 09-23-11

The indicators show continuing sluggish economic growth, and the rate of growth continues to get weaker.  Six weeks ago there was an increase in the SLFSI, generated by a slight increase in LIBOR rates and a big jump in the VIX.  The SLFSI has been stable since then.  I have been doing extensive research on this indicator.  It was not designed to predict the stock market.  It is a reflection of financial risk, based upon what happened in past crises.  I believe that it will prove valuable as a tool for investors who prefer data to story telling.  My interpretation is that it shows that European concerns should not yet be a warning to US equity investors.  This article helps to explain how to interpret the values and also provides historical context.

The ECRI WLI is still at about its average for the last year and significantly higher than in 2009.  The growth index uses an unspecified formula to smooth the changes in the index over an unspecified time.  The ECRI warns against making too much out of declines in this indicator alone unless it is persistent.  Their most recent public announcements repeat a multi-month theme:  Sluggish growth increases the risk of recession.  This makes sense to me.

My favorite take on the ECRI, carefully comparing it to other sources, comes from Doug Short.  His masterful charts capture a lot of information in a helpful way.  Here is his latest take on the ECRI:

ECRI-WLI-growth-since-1965

This is very interesting, but none of us likes a black box where the reported series is not the best source and we need an official interpretation from the actual “long leading indicators.”  I am exploring alternatives, and I hope to interest Doug in the quest.

Our “Felix” model is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. We have a long public record for these positions.

We voted “Bearish” this week, reflecting the terrible overall ratings and our long position in one of the inverse ETFs.

[For more on the penalty box see this article.  For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I’ll do my best to answer.]

The Week Ahead

There is nothing much on the economic front until Friday.  There will be some housing data, but it is not very timely.

Various Fed speeches are on the docket, including one by Bernanke.  Fresh news from anyone would be a big surprise.

I am also not too interested in the various regional Fed surveys.  The initial claims report on Thursday will be important,  Personal consumption expenditures and the Chicago Purchasing managers (both on Friday) are also of interest.

Trading Time Frame

In trading accounts we were 40% short the market at the start of the week and covered half of that position on Thursday afternoon.  We still have a bearish vote on the market with a three-week time horizon.  Nearly all of our ETF positions are in the Penalty Box, meaning that confidence in forecasts is low for us.  It should be for you as well!

Investor Time Frame

In our ETF-based Dynamic Asset Allocation program, the portfolio remains very conservative.  This cautionary posture includes bonds, gold ETFs, and utilities.  It is conservative, but has no short positions at this time.

Long-term investors should buy and maintain core holdings of an appropriate size.  This does not mean “buy and hold.”  I recommend an actively managed portfolio, adjusted with conditions, but one that includes stocks.  The mid-year selling has tested the resolve of many investors.  It is one thing to state a risk tolerance and another matter to watch it in action.  Investors who are staying the course have “right-sized” their positions and maintained confidence in their methods.  There are many stocks that are attractive on an earnings or dividend basis, despite all of the fear.

Final Notes

I am still doing a careful analysis of recession forecasting methods.  What if we had a method that had multi-decade accuracy in real time?  Not something that someone conjoured up later, but  a method that was in the public domain and actually used.

The fascination with the ECRI data series is interesting.  Big-time economists make forecasts based on this series with no knowledge of the composition — even when warned that the “better series” is not published.

Suppose that we had access to a method that was just as good or better as the ECRI on past data, but we also knew the components.

The advantage would be transparency.  That is also the disadvantage, since whichever spinmeisters did not like the outcome could criticize the indicators, something that no one can do with the ECRI.

Do we really want good indicators?  Transparency?  Information at a small cost — or free?

I do — and you should, too.

Check out my 2008 versus 2009 (Ginger / Mary Ann) analysis.

Recession Odds Challenge

My highest-rated sources see a recession as no more likely than in an average year — 15-20%.  A number of Street economists have nudged their odds up to 30%, without any real explanation.

I understand that there are many current sources who now think that a recession is a certainty.  Can interested readers provide pointers to any of these sources who had an effective real-time method for past recessions.  Every time I read one of these stories it is from someone who either expects a recession every year or who did some data mining to analyze history and back-fit their forecasting variables.

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