The Closing Bell
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
+1.0-
+2.0%
Inflation
(revised): 2.5-3.5 %
Growth
in Corporate Profits: 5-10%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 2.5-3.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 12460-13302
Intermediate Up Trend
12948-17948
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 1343-1424
Intermediate
Term Up Trend 1368-1963
Long
Term Trading Range
766-1575
Very
LT Up Trend 651-2007
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 29%
High
Yield Portfolio 30%
Aggressive
Growth Portfolio 31%
Economics/Politics
The
economy is a modest positive for Your Money. It was a light week for economic data; but what
we got was that tilted to the plus side: positives---weekly mortgage and purchase
applications, weekly jobless claims, November industrial production and
capacity utilization and November PPI and CPI ;
negatives---November retail sales, the October combo of inventory (up) and
sales (down) growth for both wholesale and business sectors, November small
business confidence; neutral---weekly retail sales, the October trade balance.
This week’s mixed/positive
stats following a robust week of data which followed a dismal one is consistent
with the flow pattern for the last year or more. So it is something to expect, not get
concerned and is factored into our outlook. Our forecast remains on track:
‘a below average secular rate of recovery
resulting from too much government spending, too much government debt to
service, too much government regulation, a financial system with an impaired
balance sheet. and a business
community unwilling to hire and invest because the aforementioned along with
the likelihood a rising and potentially corrosive rate of inflation due to
excessive money creation and the historic inability of the Fed to properly time
the reversal of that monetary policy.’
Update on the
big four indicators:
The
pluses:
(1) slightly stronger data than currently in our outlook. I am removing this factor not because the
economy is not performing as expected or that I am worried about recession but
because growth has settled back to its former erratic, struggling advance that
coincides with our forecast.
(2) our improving energy picture.
The US
(3) an improving Chinese economy.
While there is still some disagreement among the experts on this point
[as you know, Chinese economic reporting is viewed with suspicion by many---so
there is a lot of room for dissent even on major issues], it does appear that
the Chinese economy is starting to recover.
As the US China
The
negatives:
(1) a vulnerable banking system.
This week’s spotlight was on a $440 million loss in derivatives trading
in Austria
‘My concern here is that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and
well managed as we have been led to believe and, hence, are highly vulnerable
to future shocks, particularly a collapse of the EU financial system.’
Today’s must read (medium):
(2) the ‘fiscal cliff’. This issue is, of course, center stage at the
moment. And the scene is one of a
Mexican standoff. Both sides are yakking
up their case but little progress is visible.
More important, a crucial deadline is upon us---Obama is scheduled to
leave on Christmas break on Monday and the last day for draft legislation to be
presented for a vote before year end is Tuesday. So if these yahoos are really serious about a
compromise, then the level of activity right now should be frenetic---which
unless I am missing something, it is not.
Indeed, I understand that Boehner is going home for the weekend.
As you know, I
don’t think that missing a 12/31 deadline for a fix of the cliff is a terminal
event. Even if it takes our political
class a month or so into 2013, we will get an agreement.
But there are
two potential problems: (1) that compromise will almost surely be some Fibber
Magee and Molly half assed contraption that will do little to solve our long
term problems of too much spending, too high taxes and too much regulation, and
(2) if this process does drag on for a couple of months, it may start the
tighten the sphincter muscles of the investing class and today’s complacency
could be replaced by panic. Not to be
repetitious, but as you know, I have been of the opinion that it could take
just such a panic to get the politicians off their collective dead asses to
reach a compromise.
The good news
is that this solution is built into our Models.
A problem related to the ‘fiscal cliff’ is the
potential rise in interest rates and its impact on the fiscal budget. As I have noted previously, the US
So the risk here is two fold: [a] to the
Fed---its balance sheet is levered to the point that Lehman Bros. looks like it
was a AAA credit. So if interest rates
go up {and prices go down}, the very thin equity piece of the balance sheet
would disappear. The Fed would then be
technically bankrupt. and [b] to the Treasury---it must pay the interest
charges. Hence, if rates go up, the
interest costs to the government go up; and if they go up a lot, then this
budget line item will explode and make all the more difficult any vow to reduce
government spending as a percent of GDP and/or
manage the fiscal cliff.
(3)
rising inflation:
[a] the potential negative impact of central bank money printing. As you know, Thursday the Fed kicked on the
after burners on their ‘all in’ strategy of monetary easing. The question now is when will the rest of the
global central bankers follow suit in the world wide death spiral of
competitive devaluation?
‘The risk of a massive global liquidity
infusion is, of course, inflation. The
bulls argue that thus far, all this money has gone into bank reserves [meaning
it has not been spent or lent], that as long as banks are too scared to lend
and businesses to borrow, it will remain unspent and unlent and therefore will
have no inflationary impact. And they
are absolutely correct. But the whole
point of the Fed’s exercise, i.e. QEIII, is to encourage banks to lend and
businesses to invest. So on the off
chance that the plan works, inflationary pressures will grow unless the Fed
withdraws the aforementioned reserves before inflation kicks in.
And therein lies the rub. [a] Bernanke has already said {four times}
that when it comes to balancing the twin
mandates of inflation versus employment, he would err on the side of
unemployment {that is, he won’t stop pumping until he is sure unemployment is
headed down}. That can only mean that
the fires of inflation will already be well stoked before the Fed starts
tightening and [b] history clearly shows that the Fed has proven inept at
slowing money growth to dampen inflationary impulses---on every occasion that it
tried.
And:
[b] a blow up in the Middle East . Conditions in Syria
(4)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
This week we actually got some positive news out of Europe :
Greece UK
All in all,
this news does little to alter my opinion or assuage my concerns. The EU is a train wreck waiting to happen. To be sure, it may not occur; but if it does
the problem is that I can’t quantify the downside and nobody else seems to have
bothered to do it.
Bottom line: the US Washington
Neither will the
recently implemented QEIV help the economy.
It’s only impact on our forecast will be to raise the expected inflation
rate. To be sure, the Fed has eased with
impunity thus far; so I am reluctance to pick a date in our Models when
inflation starts to soar. But that date
is out there and we will have to deal with it at some point. The longer the Fed pumps money into the
system and the more bloated its balance sheet becomes, the harder it will be to
get the timing and magnitude of monetary tightening correct. I am fond of observing that the Fed has never
(as in not once) been successful in managing a transition from easy to tight
money without spurring inflation. This
time will be all the harder because of the enormous expansion of bank reserves.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies. The little good news we got this week
notwithstanding, the eurocrats continue to cower before necessity. Plus I have no clue how to assess the
consequences of a crisis though I believe them to be significant.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications rose,
(2)
consumer: weekly retail sales were mixed while November
sales were less than forecasts; weekly jobless claims fell,
(3)
industry: November
industrial production and capacity utilization were better than estimates; both
October wholesale and business inventories rose, but the corresponding sales
numbers declined; November small business confidence plunged,
(4)
macroeconomic: both the November PPI and CPI
dropped more than anticipated; ex food and energy they rose less than expected;
the October trade deficit was in line with estimates.
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 13135, S&P 1415) finished within their (1) short term trading ranges
[12460-13302, 1343-1424]---the S&P having failed to successfully challenge
the upper boundary of that range and (2) their intermediate term uptrends [12948-17948,
1366-1963]. They also are stuck inside a
very tight three week trading range (12982-13302, 1395-1424).
In addition, the
S&P is now challenging its 50 day moving average to the downside. A move below this indicator would be a
negative and would likely set up a challenge of the lower boundaries of the
Averages short term trading ranges.
Volume on Friday
was up; breadth was mixed. The VIX rose
above its 50 day moving average (a minus for stocks) and closed in the
narrowing zone between the upper boundary of its short term downtrend and the
lower boundary of its intermediate term trading range.
Another
sentiment indicator (short):
GLD was down and
remains below its 50 day moving average but above the lower boundaries of its
short term uptrend and intermediate term trading range. A confirmed break below
the former will likely prompt sale of a portion of our Portfolios’ investment
position.
Bottom
line:
(1)
the DJIA and S&P are in [a] short term trading
ranges {12460-13302, 1343-1424} and [b] intermediate term uptrends {12948-17948,
1368-1963},
(1)
long term, the Averages are in a very long term [78
years] up trend defined by the 4546-15148, 651-2007 and a shorter but still
long term [13 years] trading range defined by 7148-14198, 766-1575.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (13135)
finished this week about 16.2% above Fair Value (11300) while the S&P (1413)
closed 1.0% overvalued (1400). Incorporated
in that ‘Fair Value’ judgment is some sort of compromise on the fiscal cliff, a
‘muddle through’ scenario in Europe and a lowering of
the long term secular growth rate of the economy.
‘As you
know, our assumption on the fiscal cliff is that (1) there is no ‘grand
bargain’, (2) a compromise will be reached; and if not by year end then by
early 2013 and provisions will be retroactive and (3) the agreement itself will
do nothing to help the economy. That is,
taxes will be raised and spending will be barely cut, if at all. This is exactly the scenario built into our
Models; so nothing will change in terms of equity valuation unless we get a
grand bargain or our political class allows the cliff to happen.’
Given history,
it is not surprising that progress of this week’s fiscal cliff discussions got
about as far as a turtle on greased sheet metal. With two days to go before Obama leaves on
vacation and three days before legislation must the filed to be voted on before
year end, Boehner went home for the weekend---how’s that for progress?
The Market question
now is how sanguine will investors remain in the face of this game of political
chicken? The holiday euphoria may last;
but I still think that there is a strong argument to be made that a compromise will
be reached only if there is panic in the Markets that in turn forces the
politicians hands. In the end, it won’t
impact our Models; though it could change Market prices.
Also unaltered
is our forecast for higher inflation though at some point I will almost surely have
to increase the magnitude of this risk and that will negatively impact the
discount rate I use in our Valuation Model.
Despite some good news out of Europe
this week (Greek bail out, an EU banking agreement), it basically represented a
slightly more sophisticated form of can kicking than we have experienced of
late. In other words, the economic risks
to the US Europe and as well as the financial risk to
our banks of serial derivative defaults by EU banks haven’t diminished. Hence, the EU sovereign/banking debt crisis
remains the greatest threat to our Economic/Valuation Models.
Yet, investors remain as blissfully unconcerned
about the downside across the pond as about it here. As long as they do and Markets stay calm, the
eurocrats will be able to continue to kick the can down the road and ‘muddle
through’ will remain the operative scenario.
And as you know, that is the current assumption in our Models.
‘I recognize the flimsiness of such an
assertion. However, while I may believe
that the odds of ‘muddling through’ are shrinking by the day and may currently
be no better than 50/50, I don’t know how to quantify not ‘muddling
through’. I do believe that the
consequences will be severe: depressing economic activity (which I can
quantify) and another financial crisis (which I can’t; simply because we have
no idea how much of the notional value of current CDS’s held in the banks will
become exposed when those banks start going under).
My solution to this dilemma, as you know,
is to carry an above average cash position as insurance and to insist on lower
stock prices to reflect the risk.’
My investment conclusion: while no economic good will likely come from a
resolution of the fiscal cliff, the Market impact could be significant if these
morons continue to fiddle.
No economic good will likely come from
QEIV. Rather as I noted in Friday’s
Morning Call, it will simply continue to distort the math of investment
returns, add to future inflationary pressures, rob savers and line the bankers’
pockets. Sooner or later, I believe this
will negatively affect the rate at which future earnings are discounted.
Last
week, our Portfolios did nothing.
Bottom line:
(1)
our Portfolios
will carry a high cash balance,
(2)
we continue to include gold and foreign ETF’s in our
asset mix because we continue to believe that inflation is a major long term
risk. An investment in gold is an
inflation hedge and holdings in other countries provide exposure to better
growth opportunities.
(3)
defense is still important.
DJIA S&P
Current 2012 Year End Fair Value*
11300 1400
Fair Value as of 12/31/12 11300 1400
Close this week 13135 1413
Over Valuation vs. 12/31 Close
5% overvalued 11865 1470
10%
overvalued 12430 1540
15%
overvalued 12995 1610
20%
overvalued 13560 1680
Under Valuation vs.12/31 Close
5%
undervalued 10735 1330
10%undervalued 10170 1260
15%undervalued 9605 1190
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 40 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk
arbitrage hedge fund and an investment banking boutique specializing in funding
second stage private companies. Through
his involvement with Strategic Stock Investments, Steve hopes that his
experience can help other investors build their wealth while avoiding tough
lessons that he learned the hard way.
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