3 Indicators That Can Tell You the Market’s Next Move

On Monday, I was in the city spending some time with my friends at Yahoo Finance.  As always, I thank them for their hospitality and Jeff Macke for the engaging conversation.


With the volume and velocity of information out there, trying to get a read on the stock market is like attempting to get a sip of water from a firehose. Thankfully Paul Schatz of Heritage Capital has three ways to check the health of the market and durability of its trends. They don’t work every single time but Schatz says these are great “tells” as to whether or not what’s happening from day to day is reality or a mirage.

1. High Yield Bonds (HYG)

More commonly known as “junk bonds,” high yield corporate debt has been one of the favorite plays for investors who want decent cash flow with slightly more safety than stocks. Historically low rates on U.S. Government debt have made junk bonds an attractive way to play in between bonds and equity.

That’s why junk is the canary in the coal mine according to Schatz. Risk appetites should be relatively consistent across the board. In other words, if stocks are rising, corporate debt should be moving higher as well.

“If the market rallies and high yield does not participate that’s worry sign number one,” says Schatz.

2. S&P 400 Mid-Caps (^MID)

The S&P400 is a measure of stocks not quite big enough to make the cut for the S&P 500 (^GSPC). Companies this size tend to be hit harder by economic fluctuations than those with larger balance sheets or more lines of business. This makes the mid-caps a way to gauge the real health of the earnings environment for corporate America.

“Traditionally in bull markets mid-caps lead,” Schatz says. When the S&P 400 isn’t leading, or at least playing along with a market rally, it’s time to take profits.

3. Dow Jones Transportation Index (^DJT)

As would be expected, the Transports are a collection of 20 American companies in the business of moving things from point A to point B. Railroads, airlines, and trucking basically. Even in a virtual age most traders regard the Transports, or “Trannies” as a good gauge of underlying economic activity.

By market tradition, real bull markets only come when both the Dow Jones Industrial Average (^DJI) and the Transports are breaking out together. At the moment there’s little risk of either happening, but Schatz suggests traders stay on the lookout.

“If the Dow Jones Transports can take out the April highs I think it’s a straight 5 – 10% shot higher,” he says. Though he concedes it’s a “long way to Tipperary” before they do.

Summer Rally, Pre-Election Sell-Off


The stock market will experience a summer rally, followed by a sell-off in the fall right before the election, Paul Schatz, chief investment officer of Heritage Capital LLC, told Yahoo.

Schatz said the first half of the year had a few unique twists, but it has been fairly typical for election-year market indices.

“It’s been an interesting first half,” he said. “We were vertical for a while and then we gave almost all of it back and now we’re kind of treading water in no-man’s land.”

Schatz predicted we already had a springtime low.

“The early June lows are going to be the lows for a while,” he told Yahoo.

“We will rally and peak some time at the end of July to the end of August. Then we’ll have the traditional sell-off before the election, postconventions.

“Stocks already had the summer declines we saw in 2011 and 2010,” he stated. “It’s rare when you see it three years in a row. … I don’t think it’s anything near what we saw last year.”

After the election, Schatz expects a year-end rally.

“So many of the bogeys for the market are known, everyone is worried about the same thing — the fiscal cliff, the euro, Greece, Spain, Italy — they’re all on the table now,” he added.

Schatz predicts that the problems in Europe will loom for the next several years.

“They’re going to get their act together this decade. It may take three, five or seven years to get their act together, because the alternative is nonexistence,” Schatz noted. “I mean Europe won’t exist. I’m not talking about the euro, I mean the continent.”

Europe will take its “sweet time,” but will be fine in five to 10 years.

“We’ve been underweight Europe forever and will stay underweight,” he added.

Regarding the fiscal cliff, Schatz said, “When push comes to shove, the lame duck Congress comes in, they make the middle-class tax cuts permanent, they extend the upper-class tax cuts for another six, 12, 18 months and let the next group worry about it.

“But I don’t think they’re going to solve that now,” he added. “There’s no impetus, there’s no catalyst for it.”

By the end of the year, Schatz predicts that the S&P 500 will be “1,400ish” and says he will keep an overweight position in biotechs.

Meanwhile, the so-called “fiscal cliff” looming at the start of 2013 with planned tax increases and spending cuts may begin to push the U.S. into a recession as early as the second half of this year, Bank of America’s top U.S. economist Ethan Harris tells Fortune.

Last month, the Congressional Budget Office warned the fiscal cliff could cause GDP to shrink by 1.3 percent in the first half of 2013, even as many economists are betting the politicians in Washington will cut a deal to avert the worst effects of the measures.

Harris says the fiscal cliff will begin to make itself felt long before it actually takes effect. Corporate earnings will slow in the second half and job growth may drop to nothing by October, pushing the United States towards the brink of another recession.

Read more on Newsmax.com: Heritage Capital CIO Expects Summer Rally, Pre-Election Sell-Off
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What would Thomas Jefferson Say to the Architects?

The latest Street$marts is out, “What would Thomas Jefferson Say to the Architects?” http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20120625.pdf

Topics in this issue include a little known, but important economic indicator, the latest pullback in stocks and where gold is headed.

Fed Day is Here

Today is Fed day with split announcements.  At 12:30pm, the official announcment and statement come out and then Ben Bernanke will hold his press conference at 2:15pm.

The Fed is not going to move rates.  They will likely downgrade their view of the economy.

So far in 2012, every single Fed statement day has been a big day for the bulls. 

The market is anticipating some extension of stimulus or outright quantitative easing (creating money to buy securities, likely in the bond market).  If the Fed obliges, I look for stocks to extend the week’s gains.  If not, we should see a quick downdraft and then another rally attempt.

The Week Ahead

With earnings season over and the monthly jobs report behind us, markets will likely focus on Europe and the outcome of ObamaCare before the Supreme Court which is due out this month on a Monday.  Heading in to this week, the bulls have the upper hand after putting in at least a trading low last Monday.  You can read the details in Street$marts, which is also posted http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20120605.pdf

With the Dow at 12,550, we could see 12,750 – 13,000 this month and into July before the next bout of weakness hits.  I would give the upside the benefit of the doubt until 12,300 is seen again.  Unsexy sectors like telecom, healthcare, consumer staples and utilities all behave well and should offer decent risk/reward.  The problem is that these are defensive in nature and not what you want to see lead the way in very healthy bull market, but we’ll see what kind of quality we get during this rally before turning negative again.

Can You Trust the Experts?

One story related by Peter L. Bernstein in “Against the Gods: the remarkable story of risk” was the experience of Kenneth Joseph Arrow, an American economist and joint winner of the 1972 Nobel Memorial Prize in Economics.

Some officers had been assigned the task of forecasting weather a month ahead, but Arrow and his statisticians found that their long-range forecasts were no better than numbers pulled out of a hat. The forecasters agreed and asked their superiors to be relieved of this duty. The reply was: “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”1

Philip Tetlock, a psychologist at the University of California, Berkeley, has literally spent a lifetime looking at how well experts in their field do with respect to their professions. Over a period of 20 years he collected the predictions of 284 people who made their living “commenting or offering advice on political and economic trends,” including journalists, foreign policy specialists, economists and intelligence analysts. By the end of the study, Mr. Tetlock had quantified 82,361 predictions. How did the experts do? The vast majority of the predictions were worse than random chance. Post graduate degrees offered no advantage. Famous experts tended to do the worst.

Where did these individuals go wrong? According to Mr. Tetlock the main reason was overconfidence. Convinced that they were right, the experts ignored evidence suggesting they might be wrong. Another important bias is that most experts find it very difficult to make a negative prediction. Fear of “crying wolf” may be part of the reason, but there is also a desire to please the audience and be re-elected, or asked to speak again. Another important cognitive bias, Mr. Tetlock points out, is that most of us find it very difficult to change our minds.

Overconfidence and “confirmation bias,” where experts ignore evidence suggesting they are wrong, are of particular concern to investment advisers. With the financial security of our clients at risk, we can’t afford to become “prisoners of our preconceptions,” as Mr. Tetlock puts it. This is one reason why active management relies heavily on non-emotional, technical and quantitative analysis and mathematical relationships within the financial markets. Our goal is objectivity and discipline, checking our ego and emotions at the door.  The most important information for an active manager is not where the market has been or where we believe it is going, but where it is today.

By setting very specific investment rules as to when an asset will be purchased or sold, or when it is safe to be invested in equities or bonds or a specific sector, or when a defensive posture is better, our goal is to avoid letting our biases and emotions influence our decisions. I may be right in my belief that the market will recover from its current malaise, but to base a client’s portfolio on that belief ignores the consequences of being wrong. What if I am right on the market’s direction but completely wrong on the duration of the problem?

Active management is risk management. As with all tools to limit risk, it can also result in lost opportunities if conditions change quickly. But without risk management, without basing investment decisions on where the market is today, the risk of a major drawdown impacting the client’s future increases.

1 Against the Gods, Peter J. Bernstein, page 203.

The Facebook Fiasco… A Guide of How NOT to IPO

Here is the latest Street$marts with a detailed article on the bust that is Facebook.


Facebook, Facebook, Facebook

Is the world so boring a place that unless we can beat a story stock to death, there is nothing else to report?  Have we forgotten about the need to create jobs in the private sector? 

First it was Apple; then it was JP Morgan; and now it’s Facebook.  Thankfully, the IPO is over, Mark Zuckerberg is now worth $19B and the markets have created thousands of new paper millionaires.  It also means that in a few weeks, the buzz about Facebook should die down. 

For full disclosure, I am not an IPO investor and never have been.  I think there is too much risk and too much volatility.  For every huge success, there are dozens, hundreds or even thousands of busts.  Sure, folks can point to Apple, Microsoft and Google, but in each case, by waiting and possibly paying a higher price, you could have reduced risk and volatility, and more importantly, gave yourself better odds at winning by making sure the company wasn’t the latest flash in the pan, like At Home.com, Krispy Kreme and Boston Chicken.

All huge IPOs seem like can’t misses.  Is Facebook a good investment?  A good company?  Over the long-term, I have no idea at this point.  Time will tell.  But what we do know in the short-term is that insiders sold an awful lot of stock at a rich valuation that was increased over the past month with the likelihood of much more over the coming months and years.  The word “greed” enters into my mind!

Right now, Facebook dominates the social media space.  Zuckerberg built a monster as a private company.  That has all changed.  He and the company will now be in the public spotlight like no freshly public company has ever been. The pressure from Wall Street, the media and investors is going to be enormous.  

Here is an article I was quoted in over the weekend about the IPO. 

Fast forward a few days to May 21, we now see that the IPO is basically a bust in my opinion.  The underwriters, led by Morgan Stanley, had to commit millions of dollars of their own money on Friday to support the IPO price of $38.  The NASDAQ completely bungled the most high profile IPO since Google, if not ever, with system problems on Friday.  And today, Monday, with a very strong technology market, Facebook closed down more than 10%.  I imagine investors are shellshocked, dumdfounded and pretty angry overall.  Anything but this was expected.  To have the stock close below the offering price at all, let alone on day two is beyond unbelievable!

How happy are the institutions who bought at $38 on Friday?  Given the litigous nature of our country, I have a feeling that we will be seeing some class action lawsuits on the way.

As always, Caveat Emptor!

The Most Unloved Investment

Last Wednesday, I participated in an interesting discussion on CNBC’s Closing Bell regarding what I consider to be the most “unloved” investment.  Most continue to scratch their heads as to why they haven’t cratered with the trillions of the dollars our Fed has created over the past few years.  But there are bigger stories at play. 

For years, most have thought that inflation would really kick into high gear, but that certainly hasn’t happened.  You may have seen it at the pump or at the grocery store, but those are considered “transitional” and easily cured with higher prices.  Think about it.  The higher the price goes for a certain good, the more likely we are to cut back and/or find a substitute.  I am a big chicken eater,  but if the price of chicken doubled, tripled or quadrupled, guess what, I would find something else to eat like turkey.

That may be all well and good for chicken, but what about heating my house with oil?  Aren’t I stuck? After crude oil skyrocketed to $147 in 2008, alternatives really started to sprout up.  Americans dramatically cut back on miles driven and oil used at home.  They also started purchasing wood burning and pellet stoves, solar panels and geo-thermal systems.  In most cases, there are always ways!

Anyway, I digress.  Since 2007, I have believed that our biggest enemy would  be and is deflation, not inflation.  During the credit crisis, trillions and trillions were “vaporized”. Remember all those alphabet soup products that banks were inundated with?  CMOs, CLOs, CDOs, SIVs.  The ones that were AA and AAA but really were junk?  Think of all that money that went away!  Although the Fed has created trillions, it hasn’t come close to replacing the money that was lost. 

Wages are a component of inflation and wage growth has been essentially non existent.  And the elephant in the room, housing?  That’s the largest component of inflation and it would be very tough to argue that housing prices are and have been on the rise.  So in my opinion, we are in need of a little, controllable inflation. 

So I think I uncovered a good future topic.  Enjoy the video.


Stocks at Inflection Point

Here is the article based on my interview with CNBC’s European Closing Bell from May 1.


The 2012 bull market still has further to run, according to Paul Schatz, president of Heritage Capital, an independent investment banking and advisory firm. Instead of a major selloff, Schatz believes that the equity markets will only peak later on in the year, or early in 2013. But he’s undecided about whether this will incorporate a “sell in May and go away” mantra.

Fuse | Getty Images

“We see two possible paths. One is that the major indices go right back to new 2012 highs in May and then race to all-time highs in the third quarter or early fourth quarter,” he told European Closing Bell. “The other scenario is that stocks use May to pull back and take out the April lows before bottoming and then heading to new 2012 highs in the third quarter.”

Schatz’s reasoning is that the huge amount of central bank liquidity in the system is only going to get bigger.

“The Fed remains, and there’s still a torrent of liquidity in the system,” he said. “The ECB is just warming up. They have printing presses for trillions and trillions of stimulus for the rest of the decade.”

Schatz also downplayed the effect of the euro zone debt crisis on the equity markets. “It’ll be hard-pressed to say that Spain being in a recession[cnbc explains] is going to end this bull market.”

Even though Schatz is bullish in equities, his company still has a sizeable position in U.S. Treasuries.

“The U.S. fiscal house may not be in good shape, but on a relative basis, it’s better than most of Europe and Japan and there remains a sizeable bid under the market from the Fed and foreign governments,” said Schatz.