However, what began as a siren song of riskless gains back in November could be shifting in pitch and tempo. The Dow has risen or fallen by 100 points or more for 5 straight sessions. What’s more, over the last month, the SPDR Dow Jones Industrials (DIA) has oscillated an average of 1.25% between its highs and its lows; DIA wavered in an average range of just 0.75% from January to mid-May.

Consider what transpired on Monday, 6/17. When a Financial Times article suggested that the Federal Reserve would confirm an intention to slow its bond-purchasing program, the Dow rapidly shed 150 points. Shortly thereafter, the author of the piece explained via Twitter that he had merely expressed an opinion, and the benchmark recovered 75 to finish up 109 points.

Are we now at a point where any and all appetite for equities depends solely on what the U.S. central bank says about its future intentions? Fortunately or unfortunately… yes. Not only is the recent rise in the average daily trading range directly attributable to Chairman Bernanke’s tapering comments back on May 22, but every other force that might move equity markets (e.g., corporate earnings, technical resistance/support, macroeconomics, etc.) takes a back seat to central bank chatter.

The increase in volatility has led many to reason that the Fed will clear the air on Wednesday, June 19; that is, one way or another, taper or no taper, Bernanke will provide us with greater clarity. Many also reason that a decision to slow down bond purchasing will be a near-term negative for stocks, whereas a firmer commitment to the current course of quantitative easing will be a near-term positive for the bulls.

But what if there is a third scenario? What if members of the committee prefer to see more economic data over the course of the summer before making an unambiguous commitment? What if Bernanke and others see value in the ambiguity? Isn’t it possible that a definitive tapering message might send rates soaring and stocks tumbling? Isn’t it possible that an unequivocal pledge to $85 billion per month might send rates back below 2% and stocks rocketing without resistance?

The more thought that I give the matter, the more I believe that we’re going to get Greenspan-style ”Fed Speak.” After all, an uptick in market volatility may be far more desirable to voting members than unbridled risk-taking or a shockingly swift downward spiral.

It follows that the best exchange-traded funds for more Fed uncertainty (a la the “third scenario”) will be those that are perceived as defensive, yet less rate-sensitive than utilities or real estate investment trusts. Consumer Staples, Pharma, Medical Devices, Aerospace/Defense — exchange-traded trackers in these arenas are best equipped for ongoing Federal Reserve vagueness.

Going into Wednesday, I have my clients positioned for a bit of a setback. I raised cash in areas that have fallen below key trendlines and/or hit my stop-limit loss orders.  That said, I feel that ongoing Fed-inspired volatility still bodes well for consumer defensive funds and health care ETFs like SPDR Select Health Care (XLV).

First, I am giving a presentation as part of Tradestation’s free educational series.  It is today at 4:30pm and will focus on overnight trading and edges.  You may use the link below for more information and to register.

https://www.tradestation.com/en/education/events/webinars-schedule

Second, tomorrow will be a Fed Day.  I have posted a substantial amount of research related to Fed Days over the years.  Here are a few things you may want to note.

In September of 2012 I showed that Fed Days have shown a strong upside inclination when SPX does NOT close at an intermediate-term high the day before:
http://quantifiableedges.blogspot.com/2012/09/the-impact-of-intermediate-term-highs.html

You may use the “Fed Study” label to browse through all my Fed-related posts over the years:
http://quantifiableedges.blogspot.com/search/label/Fed%20Study

Of course my most complete collection of Fed Day research is in the Quantifiable Edges Guide to Fed Days, which it looks like Amazon has on sale at the moment.

Meantime, the key risk in the months ahead can be summed up in one question: How will the end of the Federal Reserve’s quantitative easing monetary policy strategy impact housing? Interest rates aren’t likely to rise any time soon, certainly not in tomorrow’s FOMC announcement. But with growing confidence that modest growth for the economy is the likely path ahead, the crowd’s increasingly focused on the recent rise in mortgage rates and what it means for housing recovery going forward.

The average 30-year fixed mortgage in the US has jumped to nearly 4% through last week vs. 3.3% at the end of 2012. So far, the higher costs of financing home purchases hasn’t hurt the housing market per se, in part because rates remain near record lows, even after the recent increases. New home sales in April, for instance, remained near post-recession highs while home prices generally continue to increase.

New residential construction’s annual pace remains strong as well, with housing starts climbing 20% in May vs. the same month a year ago. That’s off the highest growth rates reached in recent months, but it’s inevitable that the pace will slow as the cycle moves into the equivalent of middle age.

That said, the outlook is still bright. Confidence in the homebuilding industry jumped to a seven-year high in yesterday’s June update, according to the National Association of Home Builders/Wells Fargo Housing Market Index. “Builders are experiencing some relief in the headwinds that are holding back a more robust recovery,” NAHB Chief Economist David Crowe said in a press release. “Today’s report is consistent with our forecast for a 29% increase in total housing starts this year, which would mark the first time since 2007 that starts have topped the 1 million mark.”

Higher rates in theory create headwinds for real estate activity, but it’s easy to overstate this risk factor while mortgages remain near historical lows. Much depends on how and when the central bank moves monetary policy to something approximating normality. That’s a big unknown at this point in terms of timing and degree. Assuming the process is handled properly (and there’s no reason to assume otherwise at this stage), it’s reasonable to expect that housing will continue to be a net plus for the economy for the foreseeable future. The mistake is assuming that housing will continue to grow at extraordinary high rates. That phase is probably behind us.

His investments had appreciated nicely over the years. What’s more, he was proud of the fact that a 65% allocation to income assets had helped offset the severe setback that growth assets experienced in the 2008-2009 financial collapse. Nevertheless, he couldn’t shake the feeling that “buying-n-holding” popular asset groups was starting to fail him.

Without knowledge of the particulars, my guest had stumbled onto an inconvenient truth; that is, the Federal Reserve’s quantitative easing program forced investors to move money to destinations that they ordinarily would not have considered. Moreover, the ever-changing uncertainty surrounding the future of the central bank’s dollar printing and subsequent bond buying may be minimizing the benefits of spreading one’s money across asset types.

Most advisers recommend a minimum of 20% of one’s stock holdings allocated to foreign countries. Other advisers are even more bold, suggesting that one weight their holdings by market cap such that 50% of one’s stock holdings represent foreign companies. Keep in mind, the so-called “lost decade” of 2000-2009 was a lost decade for U.S. “buy-n-holders,” not for those who owned emerging markets and foreign developed country stocks; international stocks compounded rather nicely in the period.

Over the last 6 months, however, the U.S. stock market has dramatically decoupled from world equities; holding-n-hoping has only contributed to portfolio drag, not portfolio growth. Granted, 6 months can hardly be construed as a long-term horizon. Yet even a bull market perspective demonstrates greater volatility/risk with foreign equities for significantly less reward. Note: The chart below compares the S&P 500 SPDR Trust versus the iShares All-World excl U.S. Fund (ACWX).

Commodities? The global growth slowdown from China to Europe has decimated the prospects for alternatives like metals, materials, fertilizer and other natural resources.

Investors had been doing alright with income investments like investment grade bonds, high yield bonds and preferred shares. On the other hand, the slightest hint by the Fed that they might start to taper has damaged the prospects of virtually all income producers. 30-year mortgages up from 3.4% to 4%-plus? A 10-year yield up from 1.60% to 2.25%? These are the types of 5-week moves that have sent shivers down the spines of REIT investors, as well as owners of many income-oriented ETFs.

Investors seem to be stuck, albeit temporarily, with the notion that the closest thing to a reasonable risk-reward exists with U.S. equities. Yet even that is showing plenty of signs of cracking; daily Dow swings of greater than 100 points is rarely a vote of confidence… even when the closing price does settle near the flat line.

In sum, I expect U.S. stocks to succumb to the selling pressure that has rattled virtually every other asset type. By the same token, I expect the Fed to strongly reassert its commitment to its current $85 billion per month in bond purchases in its upcoming June meeting. Fed officials will likely steer clear of the tapering talk that has rattled yield producers as well as the markets at large. The result? The investment community will eventually re-embrace funds like iShares Preferred (PFF), iShares High Dividend Equity (HDV), Vanguard REIT (VNQ) as well as PIMCO 0-5 Year High Yield (HYS).

Note: Don’t count on the Fed to help international equities or commodities. These assets will likely require foreign governments and foreign central banks to enact the easy-going fiscal and monetary policies that investors crave. Whether those ultra-accommodative policies are beneficial to respective economies is entirely another matter.

We’ll start with the SP500 ‘Bull Market’ chart from the March 2009 low to present:

From the bigger picture perspective, the strong bull market took price from the 666 low to the recent 1,687 high ahead of the recent ‘pullback’ or retracement against the dominant trend.

The Primary Trend (greater than 2 years) and the Intermediate Trend (6 months to 2 years) has remained bullish (uptrending) since the 2009 reversal low.

There have been two main counter-trend retracements (mid-2010 and mid-2011) both of which corresponded – coincidence perhaps – with the end of QE1 and QE2 stimulus programs.

All other retracements including the two events in 2012 have been relatively shallow events on the larger scale.

While that’s the backdrop or structure of the trend, we turn our attention now to the key inflection or reference levels for swing and even intraday planning with respect to the broader trends.

Again, the primary and intermediate trends continue to be “bullish” and we note the three shallow pullbacks or retracements to the rising 20 week Exponential Moving Average (EMA) in 2013.

The major question (for planning) is whether 1,600 will hold as support and thus the market will continue the strong uptrend and thus trade back to the all-time high and then above it beyond 1,700, or else whether sellers will turn prices lower particularly on a breakdown under 1,600 which sets up an expectation of a deeper retracement back to the rising 50 week EMA (at least) just above the 1,500 reference level.

For the moment, support held two times (a potential double bottom) and the recent bullish action suggests additional pro-trend continuity.  We’ll continue monitoring the price action relative to these higher frame levels including 1,600.

The Dow Jones shows a similar history and current reference levels for swing and position planning:

The immediate focal level for the Dow Jones is the round-number reference 15,000 index level though the rising 20 week EMA resides near 14,700.

For planning purposes, a breakdown under 14,700 strongly suggests that the index will continue the sell or liquidation swing (counter-trend retracement) toward the dual support confluence of the rising 50 week EMA and “round-number” reference at 14,000.

Otherwise, continued upside action suggests that the bullish pro-trend structure and environment will continue with bullish trades that develop along the pathway back to – and then above – 15,500.

The NASDAQ Weekly Chart:

Finally, we note the key reference levels in terms of a Trend Continuity (bullish short-term trading strategies) or else deeper retracement (hedging/bearish/cautious strategies) outcome.

For the NASDAQ the planning levels include the current “round number” reference of 3,400 along with the rising 20 week EMA (note how it held support two times in 2013) into 3,330.

A sharp breakdown under 3,330 suggests that price will continue a deeper retracement toward the 3,200 confluence.

Always take into account both bullish and bearish pathways and use price as a guide for supply/demand imbalance (what’s happening) at key reference levels.

Always ask whether price is moving away from a key level or toward a level and develop short-term trading strategies based on the price movement and low-risk opportunities that develop in the context of the broader perspective of the weekly chart.

It won’t be an easy conversation for Bernanke to have and with a press conference scheduled he will have to answer some tough questions from reporters.  The Federal Reserve is widely expected to lower its inflation and GDP forecast because growth and price trends are weaker than what the Fed anticipated back in March.  Nonetheless, we continue to see gradual improvements in the U.S. economy.  For example, according to the Empire State survey, which rose from -1.43 in May to a 3 month high of 7.8 in June, manufacturing conditions in the NY region recovered after pulling back last month. This may only be one piece of early U.S. data but it provides hope for the U.S. economic outlook.   U.S. consumer prices, housing starts and building permits are scheduled for release tomorrow.  Inflationary pressures are expected to tick up slightly due to higher gas prices but housing starts and building permits are expected to reverse some of the past month’s changes.  Starts fell sharply in April and are therefore expected to rebound in May but permits are expected to fall after soaring the month prior.  Overall, low rates in the U.S. are supporting the housing market so no major downside surprises are expected in tomorrow’s report. In the meantime speculation about the possible outcome of the Fed Meeting will dominate financial market moves leading up to Wednesday’s FOMC announcement.

EUR – Unclear How ZEW Survey Could Fare

The euro ended the day slightly higher against the U.S. dollar, recovering earlier losses near the end of the NY session.  The region’s trade surplus shrank to 14.9 billion euros from 22.5 billion euros on weaker trade activity in Germany and France.  Month over month exports declined and imports increased despite the drop in energy imports. While the softer trade balance prevented the euro from rising today, the impact on the currency was limited. Instead, tomorrow’s German ZEW survey of investor confidence should have a more significant impact on the currency.  Economists are looking for a small uptick in sentiment because more recent economic reports have shown gradual improvements in the region’s economy. However with the recent volatility in the financial markets, we would not be surprised if investor sentiment remained unchanged or deteriorated.  Meanwhile between the G8 Summit, euro area finance ministers meeting and EU finance ministers meeting, we can expect a number of comments from European officials. ECB President Draghi speaks tomorrow but he may not touch on monetary policy because the speech is at a farewell conference for the Bank of Israel Governor.  The last time we heard from Draghi he said Germany’s biggest export market “should stabilize and recover in the course of the year, albeit at a subdued pace” this year but there may be less domestic and global demand for euro-area goods.”  The focus for Europe this week will be Thursday’s PMI reports but the ZEW survey can also cause some volatility for the euro.

GBP – Still Testing 1.57, All Eyes on CPI

The British Pound ended the North American trading session virtually unchanged against the U.S. dollar and euro. The only piece of U.K. data released over the last 24 hours was house prices and according to the report, prices rose 1.2% adding to a sixth consecutive month of increase. The survey taken by Rightmove revealed that “the national average asking price of a property coming to a market is over a quarter of a million pounds for the first time.” Rightmove believes that higher confidence, lower mortgage rates and prices affected by inflation promoted additional housing market activity. In the survey it says, “Property market recoveries are traditionally led by London and, belatedly, the trend set in the capital now appears to be spreading as a broader housing market recovery is potentially on the cards.” The Bank of England’s Funding for Lending Scheme and the government’s Help to Buy Scheme have helped improve housing market activity by making loans easily assessable. Inflation reports are scheduled for release tomorrow. Consumer prices are expected to grow at a slower pace but on annualized basis, CPI is expected to hit 2.6%, up from 2.4%. According to the British Retail Consortium, shop prices declined last month, which confirms that inflationary pressures declined.  Weaker CPI could stall the GBP/USD rally ahead of the BoE minutes and Thursday’s retail sales report.

AUD – What to Expect from RBA Minutes

It was a rollercoaster ride for the commodity currencies today, which rallied in the early U.S. hours, declined during the day only to squeeze higher towards the end of the NY session.  This volatility suggests that currency traders are not convinced that the outlook has improved enough for risk currencies to rally. Mitsubishi’s decision to suspend its $5.9 billion iron ore project in Australia may have contributed to the AUD/USD decline but hardly explains the intraday reversal in the NZD and the CAD especially since Canadian and New Zealand data was good. Foreign purchases of Canadian denominated securities hit a 7 month high in April. With Canadian data continuing to improve and oil prices extending higher in June, we suspect that foreigners have boosted their exposure to Canadian even further.  In New Zealand, consumer confidence increased in the second quarter and service sector activity held steady after being revised higher in April. The minutes from the most recent Reserve Bank of Australia monetary policy meeting will be released this evening.  If you recall, when the central bank last met, they refused to drop their bias to lower rates choosing instead to say that while the exchange rate has depreciated, “it remains high considering the decline in export prices.”  A day later, we learned that GDP growth slowed to its weakest level since 2011, which may explain why they left the door open to lower rates.  The RBA minutes are therefore expected to remind the market about the central bank’s level of dovishness which could translate into additional losses for the Australian dollar.

JPY – G8 Summit and Abenomics

The Japanese Yen traded lower against nearly all of the major currencies today as the recovery in Japanese and U.S. stocks lifted risk appetite. The G8 leaders Summit is underway and while the civil war in Syria is on the top of the agenda, Prime Minister Abe is expected to be asked a variety of questions on Abenomics but we don’t expect anything specific to be included in the communiqué. Previously, some leaders felt that Japan was deliberately weakening its currency but with the Japanese Yen appreciating more than 9% since the middle of May, Abe could easily point to the move and say that their accusations are not true. As a result, we don’t expect the G8 Summit to have a dramatic impact on the Yen. According to the CFTC’s Commitment of Traders report released on Friday, speculators are still very net short yen. While the data was as of June 11th when USD/JPY ended the day at 96, we doubt that positioning has changed that much since then.  The data suggests that speculators still feel that Abenomics will weaken the Yen and until some of those short positions turn into longs, the Bank of Japan will be hesitant about intervening in the currency. The latest Japanese economic reports show continued improvements in Japan’s economy. While the Tertiary activity index fell short of expectations, the number terrible isn’t when taking the sharp upward revision to the last month’s report into consideration.  Condominium sales in Tokyo also jumped 49.2% year over year.  Industrial production and Machine Tool orders are scheduled for release this evening but as final reports, they are not expected to have a major impact on the Japanese Yen.

After weeks of speculation based upon speeches, newspaper columns, and pundit pontification we will finally have some hard information. Maybe. The two-day FOMC meeting will include not only the regular announcement of the decision, but also revised economic forecasts and a press conference by Chairman Bernanke. Everyone will be watching for any hints of a change in policy.

1. Will the Fed reduce the pace of the current QE purchasing?
2. If not, will it provide more information about the timing of a possible change?
3. What might be the size of any reduction?

Those expecting early action seem to focus on September. Tim Duy reviews the most recent data and concludes, “Bottom Line:  Today’s data appears consistent with Fed expectations that they can begin tapering asset purchases this year.  Still a horse race between September and December, although I think the Fed is aiming for the earlier date if data allows.”

Those expecting later action point to the lack of inflation. Recoveries from recession are usually stronger and faster; that usually means inflation. Rex Nutting notes that it is the lowest core inflation in history.

Bloomberg (via Josh Brown) compares inflation to past recoveries. Josh concludes that the Fed has time to jawbone rather than changing policy. Here is the key chart:

If the Fed does change course, what will be the result?

Most market observers expect a major reaction at the first sign of a Fed policy change. They are not waiting for an actual increase in interest rates, but getting ready to head for the exits at the first sign of a policy shift. This analysis from Barclays, cited in The Economist, is typical. It shows the “sensitivity” of various markets to changes in the Fed balance sheet. There is no attempt to show a causal mechanism.

Intone after me:

Fed prints money. Liquidity, liquidity. POMO, POMO. Asset prices move higher – all of them!

I have some contrarian thoughts about what to expect from the Fed. I’ll elaborate in the conclusion, but first, let us do our regular update of last week’s news and data.

Background on “Weighing the Week Ahead”

There are many good lists of upcoming events.  One source I regularly follow is the weekly calendar from Investing.com. For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at “A Dash” where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!
Last Week’s Data

Each week I break down events into good and bad. Often there is “ugly” and on rare occasion something really good. My working definition of “good” has two components:

1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
2. It is better than expectations.

The Good

On balance, this was a good week for economic data.

• S&P revised the outlook on U.S. debt to stable from negative. Do we really care?
• Year-over-year growth in expected earnings is stronger (via Brian Gilmartin). This comparison deserves more attention.
• Initial jobless claims surprised and declined to 334K. There is less firing, but we still need more hiring!
• Retail sales showed a surprising gain, even after subtracting higher gasoline sales. There is solid growth but less than expected from a normal recovery. Scott Grannis has a good analysis with a Fed related theme and many helpful charts. Here is the retail sales “control” group version:

The Bad

There was some bad news, but probably not as important.  Feel free to add in the comments anything you think I missed!

• Pump and dump is back. Investors who feel like they have missed the rally are trying to catch up in the wrong way. The SEC and FINRA are warning about an increase in scams.
• The PPI increased by 0.5%, mostly reflecting energy prices. In the long run, we care about food and energy costs, but the year-over year change was only 1.7%.
• Another debt ceiling debate looms (via The Hill). This can put a lid on job growth.
• Rail traffic is stagnating (via Cullen Roche). Contrary view from GEI, using different comparisons.
• Industrial production was flat, missing expectations. James Picerno has a nice analysis, advising that the indicator bears watching but is not yet a “smoking gun.” Here is one of the useful charts:

• Chinese growth is losing some momentum, but still relatively high (via Ed Yardeni).

The Ugly

Congress is a repeat winner of the “ugly” award. It seems like there is often something new. Gallup reports that confidence in Congress has hit an all-time low of 10%, down 3% from last year. One reason for poor performance might be lack of knowledge and attention. The Hill reports that the majority of the Senate preferred to check out early for the weekend rather than to attend a classified briefing on NSA snooping.

There were some other candidates this week, so feel free to add your own ideas in the comments!

The Indicator Snapshot

It is important to keep the current news in perspective. I am always searching for the best indicators for our weekly snapshot. I make changes when the evidence warrants. At the moment, my weekly snapshot includes these important summary indicators:

• For financial risk, the St. Louis Financial Stress Index.
• An updated analysis of recession probability from key sources.
• For market trends, the key measures from our “Felix” ETF model.

Financial Risk

The SLFSI reports with a one-week lag. This means that the reported values do not include last week’s market action. The SLFSI has recently edged a bit higher, reflecting increased market volatility. It remains at historically low levels, well out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a “warning range” that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

Recession Odds

I feature the C-Score, a weekly interpretation of the best recession indicator I found, Bob Dieli’s “aggregate spread.“  I have now added a series of videos, where Dr. Dieli explains the rationale for his indicator and how it applied in each recession since the 50′s.  I have organized this so that you can pick a particular recession and see the discussion for that case.  Those who are skeptics about the method should start by reviewing the video for that recession.  Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob’s information to improve investing.  I hope to have that soon.  Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning.  Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index.  They offer a free sample report.  Anyone following them over the last year would have had useful and profitable guidance on the economy.  RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration.

Georg Vrba’s four-input recession indicator is also benign. “Based on the historic patterns of the unemployment rate indicators prior to recessions one can reasonably conclude that the U.S. economy is not likely to go into recession anytime soon.” Georg has other excellent indicators for stocks, bonds, and precious metals at iMarketSignals.

Calculated Risk joins us in concluding that there will be no recession for “some time” and also in placing a high priority on this analysis.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now over 18 months old.  Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting.  His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture.  Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

The average investor has lost track of this long ago, and that is unfortunate.  The original ECRI claim and the supporting public data was expensive for many.  The reason that I track this weekly, emphasizing the best methods, is that it is important for corporate earnings and for stock prices.  It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our “Felix” model is the basis for our “official” vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  We recently switched our stance to neutral, but it is a close call. Felix might switch to a bearish posture if the overall market drifts lower. The inverse ETFs are more highly rated than positive sectors by a small margin, but remain in the penalty box. These are one-month forecasts for the poll, but Felix has a three-week horizon.  Felix’s ratings seem to have stabilized at a low level. The penalty box percentage measures our confidence in the forecast.  A high rating means that most ETFs are in the penalty box, so we have less confidence in the overall ratings.  That measure remains elevated, so we have less confidence in short-term trading.

[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

This week brings little data and scheduled news, an artifact of the calendar and the holidays.

The “A List” includes the following:

• Initial jobless claims (Th).   Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
• Building permits and housing starts (T). Building permits are an excellent leading indicator for housing, and housing is what we should be watching.
• FOMC decision and press conference (W). The key point for the week.

The “B List” includes the following:

• CPI (T). At some point the inflation data will be more important. For now it is benign.
• Existing home sales (Th).  This is a key element of the economic rebound, so it is important to follow.
• Leading economic indicators (Th). This report is still widely followed and used by some in recession forecasting.

I am not very interested in the Empire State index or the Philly Fed report, but people will pay attention to extreme moves.

There will also be continuing news from President Obama’s travel abroad, but I am not expecting a specific market impact.

How to Use the Weekly Data Updates

In the WTWA series I try to share what I am thinking as I prepare for the coming week. I write each post as if I were speaking directly to one of my clients. Each client is different, so I have five different programs ranging from very conservative bond ladders to very aggressive trading programs. It is not a “one size fits all” approach.

To get the maximum benefit from my updates you need to have a self-assessment of your objectives. Are you most interested in preserving wealth? Or like most of us, do you still need to create wealth? How much risk is right for your temperament and circumstances?

My weekly insights often suggest a different course of action depending upon your objectives and time frames. They also accurately describe what I am doing in the programs I manage.

Insight for Traders

Felix has continued a neutral posture, now fully reflected in trading accounts which have no position in equities. Our partial position includes a bond inverse fund and a commodity. The overall ratings are slightly negative, so we are close to an outright bearish call. This could easily be the case by the end of next week. While it is a three-week forecast, we update the model every day and trade accordingly. It is fair to say that Felix is cautious about the next few weeks. Felix did well to avoid the premature correction calls that have been prevalent since the first few days of 2013, accompanied by various slogans and omens.

Insight for Investors

This is a time of danger for investors – a potential market turning point. My recent themes are still quite valid. If you have not followed the links, find a little time to give yourself a checkup. You can follow the steps below:

• What NOT to do

Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. It has already started. Bespoke Investment Group has a great chart package showing how the rush into yield-based investments is going South in a big way! Anyone focused on yield should read this post and look at the charts. The most recent victim is the preferred stock, as you can see here:

I also recommend the excellent analysis by Kurt Shrout at LearnBonds. It is a careful, quantitative discussion of the factors behind the current low interest rates and what can happen when rates normalize.

• Find a safer source of yield: Take what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked well for over two years and continues to do so. (I freely share how we do it and you can try it yourself. Follow here, and scroll to the bottom).

• Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on new events and not enough on earnings and value. Check out the ten suggestions from Barry Ritholtz, specifically aimed at those who feel they missed out on the latest market move.

Three years ago, in the midst of a 10% correction and plenty of Dow 5000 predictions, I challenged readers to think about Dow 20K. I knew that it would take time, but investors waiting for a perfect world would miss the whole rally. In my next installment on this theme I reviewed the logic behind the prediction. It is important to realize that there is plenty of eventual upside left in the rally. To illustrate, check out Chuck Carnevale’s bottoms-up analysis of the Dow components showing that the Dow “remains cheaply valued.”

• Get Started

Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. There are many attractive stocks right now – great names in sectors that have lagged the market recovery. Ignore all of the talk about the Fed and focus on stocks. One of my favorite sources, Bill Nygren of Oakmark refused to play the game in his CNBC interview this week. He would not answer the standard questions about the short term, and carefully explained why investors should take advantage of volatility to buy cheap stocks. This is also my message, and I agree with many of his specific stock suggestions. For those who were not monitoring CNBC two hours before the opening, you might have missed this great interview.

And finally, we have collected some of our recent recommendations in a new investor resource page — a starting point for the long-term investor.  (Comments and suggestions welcome.  I am trying to be helpful and I love feedback).

Final Thought

What should we expect from the Fed?

It has actually been pretty easy so far. Here are the rules:

• Pay attention to Bernanke, not speeches by others. They are free to talk in the modern era, but the message is not orchestrated.
• Do not expect a road map when there is no specific plan. When the message is that policy is “data dependent” that is clear communication. It is silly to expect more specificity from a committee. They are all looking at the evidence.
• Do not over-estimate the Fed impact. This is the most important lesson. Everyone who has been wrong about their forecasts – recessions, interest rates, stocks – has blamed it on the Fed.

These are the same people who told you that the Fed was “out of bullets.” They argued that the Fed would not be effective. That the Dow was going to 5000. These are sources that are using the Fed as a fig leaf to cover up their own mistaken analysis.

The reality is that the Fed has had a modest impact on both interest rates and the recovery in stocks. The facile, two-variable correlations between QE and various markets are flawed. Anyone doing serious economic analysis understands that many variables are changing at the same time. Consider the Barclay’s graph I cited the introduction.

Do you really think that Turkish stocks will get crushed if the Fed eases off on QE? What happened to the “correlations” that we saw with food prices and energy on the last round of QE? Notice how the comparisons change when convenient?

Fed policy has been a modest substitute for better fiscal policy. It had a modest economic effect when implemented, and will have a modest economic effect when withdrawn.

The psychological effect is another matter, and a problem for another day.

Ultimately, interest rates and stock prices will both move higher. For more explanation check out my post from the start of 2011 I predicted ten things that would be more normal. Some have proved accurate while others are a work in progress. Former Goldman Sachs Asset Management Chairman Jim O’Neill reaches a similar conclusion:

In the short term, getting back to normal probably means some fallout across equity markets, too — but this is much less likely to be lasting. Longer-term investors will want more exposure to equities, not less. Normality means a reversal in the popularity of the two main asset classes: As people fall out of love with bonds, they’ll fall back in love with equities.

Experienced traders and investors respect and understand the concept of “Don’t fight the Fed”. The basic rationale behind the expression is that when the Fed is printing money, the odds are tilted in the bulls’ favor. Conversely, when the Fed is tightening policy, bearish odds begin to pick up.

What Fight Are We Trying To Avoid?

One of the most frustrating aspects of investing during Ben Bernanke’s watch is the constant stream of conflicting messages being delivered by members of the Federal Reserve. One day the market may hear from a pro money printing Fed governor. The next day investors may hear talk of the need to “taper” the pace of the Fed’s bond buying program. The confusion in markets was evident on May 22 when the S&P 500 spiked higher early in the session as Ben Bernanke’s remarks hinted at a steady stream of money printing. Later in the session after the Fed minutes were released, the rush to buy was replaced with a rush to sell as traders began to believe Fed tapering was coming sooner rather than later.

A Prudent Fed Strategy

With the Fed due to deliver a formal policy statement this Wednesday, it makes sense to identify a line in the sand to discern between “leave my investments alone” and “I need to play some defense”. We believe the line in the investor’s sand can be drawn at 1593 on the S&P 500.

The Trend Is Your Friend

One of the reasons for exercising some patience above 1593 on the S&P 500 is based on the market’s current bullish trend. Traders use the slope of the 50-day moving average to monitor the market’s intermediate-term trend. As shown below, not too many bad things happen as long as the slope of the 50-day is positive or flat. The 50-day is shown in blue. As of noon Monday, the slope of the 50-day was still positive, which is indicative of a bullish trend.

Fed Is Fuzzy – Chart Is Clear

It is unlikely this week’s Fed statement completely removes the market’s confusion regarding the future pace of printing press utilization. From Bloomberg:

What central banks may have the world over is a failure to communicate. Officials are struggling to spell out their visions for monetary policy, often amid a chorus of competing views. Chairman Ben S. Bernanke is trying to manage expectations about when the Federal Reserve will slow asset purchases and raise interest rates. Bank of Japan Governor Haruhiko Kuroda’s reflation-push is backfiring by driving up bond yields. European Central Bank President Mario Draghi is dashing investors’ hopes he once kindled for extra stimulus. The muddied messaging already is roiling financial markets, threatening to undermine the confidence of investors, households and consumers and so undoing efforts by central banks to strengthen their economies.

Even if we had an advance copy of this week’s Fed statement, it would be difficult to anticipate the market’s reaction to it. The reaction may be one of fits and starts. The charts provide us with clear and unambiguous feedback, which is in stark contrast to trying to interpret a Fed policy statement.

Investment Implications

The number of inputs when making investment decisions are nearly limitless. Our strategy this week will be to err on the side of holding our long positions in stocks as long as (a) the slope of the S&P 500’s 50-day remains positive, and (b) the S&P 500 remains above 1593 on a closing basis. Until some conviction returns from buyers, we prefer diversified stock plays, such as the S&P 500 ETF (SPY) and technology (QQQ). If (a) and (b) above are no longer in place, we will consider more defensive positions, such as consumer staples (XLP) and bonds (AGG).

On the docket this week domestically the FOMC is meeting Tuesday and Wednesday and the SNB gets together on Thursday. While I see the US keeping rates at 0.25% and the SNB maintaining 0% the FX markets could react on comments or any indication on the timing of IR changes in the future.  The primary goal of the SNB is to ensure price stability, while taking due account of economic developments. In so doing, it creates an appropriate environment for economic growth. Translation a stronger franc is not conducive for growth moving forward. In a press release after a prior meeting, the SNB commented that “an appreciation in Swiss franc will threaten the price stability and may cause important damages to Swiss economy.” As the global economic situation is not very appetizing, the SNB said to be ready to proceed with an unlimited foreign exchange purchases to defend its currency,i.e. price manipulation as currency wars heat up.

To capitalize on potential depreciation in the Swissie I am advising bearish exposure. My suggested play is short September futures while simultaneously selling out of the money puts 1:1. The idea is to make more money in the futures leg than you lose in your put option leg while cushioning the trade if prices trade north temporarily. Those more risk averse traders just looking to play the Central Bank meetings this week could buy July put options. With only 19 day until expiration if a move does not happen immediately this will be a loser. Be willing to risk the entire premium paid. At the money strikes cost $1400 and going out two cents the cost is $550…pick your poison.

U.S. investor appetite remains surprisingly resilient in the face of major losses in Asian markets.  Perhaps investors are starting to look at individual countries as isolated entities unaffected by global developments – it is hard for us to believe this mentality is sustainable but that’s what we are seeing in the markets right now. If the Nikkei continues to decline overnight, the dollar will most likely extend its slide against the Japanese Yen but could remain steady against the euro.

A number of U.S. economic reports are scheduled for release tomorrow and if the data surprises to the upside, investors could find themselves with more reasons to ignore the volatility in the other markets and to remain in denial.  While Hilsenrath’s article is negative for the dollar, it isn’t overwhelmingly positive for stocks either because his conclusion that the Fed is no way near raising interest rates is based on the thesis that the U.S. economy is not strong enough to handle it.  Producer prices, first quarter current account balance, the Treasury’s International Capital Flow report, Industrial Production and the University of Michigan’s consumer sentiment reports are all expectedtomorrow so keep an eye on the U.S. dollar because it will be in play.  Of these releases, we feel that the UMich survey could be the most market moving as it would give us a sense of whether Americans have been affected by the turn in stocks and the slowing U.S. recovery.

JPY – When will the BoJ Cry Uncle?

While the Japanese Yen crosses ended the day off their lows, the Yen is higher against most of the major currencies. With USD/JPY falling almost 1000 pips from its peak on May 22nd to its low today, the question that many FX traders are asking now is when the Bank of Japan will cry uncle.  Both Japan’s BoJ Governor and its Finance Minister are new members of Shinzo Abe’s government.  Granted Kuroda formerly served as the head of Asia Development Bank and Aso was a former Prime Minister, both men may be struggling to deal with the volatility in Japanese markets. On an absolute level, USD/JPY is still well off its record low of 75.57 but we haven’t seen this type of volatility in the Nikkei since 2011, shortly after the earthquake and tsunami that devastated Japan. At the time, USD/JPY and the Nikkei was “saved” by G7 intervention but even though Abenomics will most likely be discussed at the next G7 meeting, the Japanese can’t expect any help from their global partners because this time, they only have themselves to blame for denying Japan additional stimulus this week and sending their markets into a downward spiral. Last night’s Ministry of Finance flow of funds report show Japanese investors selling foreign bonds once again. With the Japanese continuing to repatriate their funds, their actions are driving USD/JPY lower and not higher.  Stocks have also peaked in Japan and U.S. bond yields are lower, all of which have contributed to USD/JPY losses.  So while Abenomics is suppose to be positive for USD/JPY, so far, we have not seen its expected effects on Japanese investments, JGBs and the Nikkei, critical factors that contribute to the trend of USD/JPY.  With today’s move the currency pair has fallen as much as 8% from its May 22nd high so how much additional losses are needed before the BoJ cries uncle and verbally or physically intervenes to drive down the Yen?  Based on the percentage move and how quickly it has occurred, the BoJ should be at least trying to talk down the currency now.   However they have only defended their actions and part of the reason may be because last week’s CFTC data showed speculators net short and not long Yen.  The BoJ is a street smart central bank that likes to wait for short USD/JPY positions to build up before verbally or physically intervening in its currency to get the most bang for their buck.  At 95, many investors may have abandoned their long USD/JPY positions but at 90-92, we may start to see some investors short the currency and that is what the BoJ wants to see.  For the sake of the stock market, we think the Japanese government should act now but their stubbornness and over confidence in current policies could be clouding their judgment.

EUR – Cautious ECB Monthly Report

The euro ended the day marginally higher against the U.S. dollar as all of the action today was concentrated in the Yen crosses and commodity currencies. The only notable release from Europe was the European Central Bank’s monthly report in which the ECB said it will not change its low interest rate policy any time soon. In the report, it claimed record-low rates were appropriate to support growth. The report introduced with, “The monetary policy stance will remain accommodative for as long as necessary.” The report expressed optimism that inflation would remain low despite the record low rates. It also said it expected low inflation in the area to result in a higher domestic demand in Eurozone member states. The ECB predicts higher exports due to a recovery of the global economy but it warned that there were still many risks that can prevent a sustainable recovery in economy, despite the recent improvement in business climate. “The Governing Council continues to see downside risks surrounding the economic outlook for the euro area. They include the possibility of weaker than expected domestic and global demand and slow or insufficient implementation of structural reforms in euro area countries.” The council believes risks to the outlook for price developments are balanced over the medium term with upside risks and downside risks from weaker economic activity. Price developments should remain in check with price stability over the medium term. Eurozone CPI is the only piece of data on the EZ calendar tomorrow.

AUD – Stronger Data Drives Short Covering Rally

The Australian, New Zealand and Canadian dollars rebounded against the greenback today with AUD and NZD enjoying the strongest recoveries.  While Australian economic data surprised to the upside, the primary driver of the rally in both of these currencies is short covering.  AUD and NZD have become deeply oversold in recent weeks and due for a much needed recovery.  A total of 1100 jobs were created in the month of May, which doesn’t sound like a lot but it is when considering that economists had been looking for employment to drop by 10k.  While the data was far from unambiguously strong – full time work declined but part time work increased and the participation rate dropped to 65.2% from 65.3%, it was still good enough to encourage some short AUD traders to take profit.  Canadian data on the other hand continued to surprise to the upside as the New Housing Price index rose 0.2% in the month April.  The RBNZ’s downgrade to GDP growth Thursday morning (in New Zealand) failed to have a lasting impact on the NZD.  Tonight, we have the business PMI index scheduled for release and it will be interesting to see if New Zealand businesses have grown less optimistic in the face of a rising currency.

GBP – No News, No Volatility

The British Pound also ended the day unchanged against the euro and U.S. dollar.  George Osbourne’s 10-month old lending plans have not been as effective as economists thought. As Mark Carney comes to office in July he may have to consider new ways to boost lending. While borrowing costs have diminished since Osbourne and Bank of England Governor Mervyn King announced the program and their annual Mansion House speeches a year ago, credit is still shrinking. Former member of the BOE Monetary Policy Committee, Adam Posen, said the Funding for Lending Scheme has been “disappointing.” He said the lending plan is not working properly because it involves banks that are still not back up on their feet from the previous crisis. He said, “You have to try to go around the banking system,” and thinks that the BOE should purchase other securities besides UK government bonds. The BOE said in its quarterly report that higher inflation expectations could lead to inflation becoming more persistent but most signs are consistent with expectations remaining closely knit to the target. The report writes, “The prolonged period of above-target inflation could cause inflation expectations to become less well-anchored.” The report reveals evidence that financial market measures of inflation expectations have become a little responsive to growth in the economy. There are some who believe that prices and wages have gone up due to higher inflation expectations.