The Closing Bell
10/5//13
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
2.2%
Inflation
(revised): 1.8 %
Growth
in Corporate Profits: 16.1%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 1.5-2.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 14190-15550
Intermediate Uptrend 14971-19971
Long Term Trading Range 4918-17000
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1679-1833
Intermediate
Term Uptrend 1591-2177
Long
Term Trading Range 715-1800
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 43%
High
Yield Portfolio 46%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. The
economic stats were biased to the upside again this week, though I would add
that several important datapoints were not reported due to the government
shutdown: positives---weekly retail sales, weekly jobless claims, September ISM
manufacturing index, September Chicago PMI ,
September Dallas Fed manufacturing index; negatives---weekly mortgage and
purchase applications, September vehicle sales, the ISM nonmanufacturing index
and the ADP private payroll report; neutral---September
Markit PMI .
So the numbers continue
to reflect our forecast. Of course, the
government shutdown and concerns over the approaching debt ceiling negotiations
held center stage this week. I dedicated
much verbiage to this situation this week; so I will just summarize: the
government shutdown is a nonevent. It
would have to last for a prolonged period before there was any meaningful
impact.
Not lifting the
debt ceiling and risking a government default on its debt is a more serious
matter. Such an occurrence would drive
up US interest rates, impair the world’s use of the dollar as a reserve
currency (i.e. weaken the dollar) and be another hit to our reputation as a
strong world leader. I don’t think that
it will happen because as the deadline approaches whichever party is being
blamed by the electorate is going to have a major strategic choice: give in and
try to salvage as much goodwill as possible or carry the blame into the 2014
elections. I can’t imagine either party
being stupid enough to elect the latter.
In short, the odds are that this is all just political theater and will
have little effect on our outlook:
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 historic inability of
the Fed to properly time the reversal of a vastly over expansive monetary policy.
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1)
a vulnerable global banking system. This is a bad dream that seems to have no
end. This week, the Fed began a review
of the commodities operations of the major banks, Wells Fargo was sued over its
mortgage operations and JP Morgan [our fortress bank] is being investigated
over its role in the bankruptcy of Italy ’s
oldest bank.
http://www.bloomberg.com/news/2013-10-02/prosecutors-said-to-seek-jpmorgan-indictment-on-paschi.html
‘My concern here.....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.’
(2)
fiscal policy. No
need for repetition. See above; and read
this latest bit of analysis (medium)
I
include in each Closing Bell a lament regarding the potential impact that
higher interest rates [potentially the result of either tapering or the
inability to reach an agreement on the debt ceiling] will have on the budget
deficit. Now those risks are upon us: 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 an 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 .....
(3)
the potential negative impact of central bank money
printing: The key point here is that [a] the Fed has inflated bank reserves
far beyond any comparable level in history and [b] while this hasn’t been an
economic problem to date, {i} it still has to withdraw all those reserves from
the system without creating any disruptions---a task that I regularly point out
it has proven inept at in the past and {ii} it has created or is creating asset
bubbles in the stock market as well as in the auto, student and mortgage loan
markets.
With the Ber-nank having weaseled on
‘tapering’ and the rising prospect of super dove Janet Yellen assuming the
mantle of Fed chief, I would add another point to the above and that is, the
longer money for nothing goes on, the worse the outcome I fear. I know all the
arguments that the massive build up in reserves has not resulted in a growth in
M2 and therefore a higher risk of inflation. In fact, I acknowledge that they
are correct. However, the Fed apologists
skim over the point that all those reserves have to be removed in a way not to
cause inflation---and the Fed has never done that before.
They also fail to mention that when the
$3 trillion in government bonds are sold or allowed to mature, someone has to
either buy the bonds that are sold or the new bonds that replace the cash in
the Treasury that paid off the maturing bonds. That is a lot of new buyers and
a lot of money; with that much new supply what happens to interest rates?
They also fail to mention the
misallocation of capital, the hardship to savers, the encouragement to
speculators that result from artificially low interests and the distortions those cause to our
economy, i.e. slow growth and high unemployment. In sum, QEInfinity [except for QEI] has done
nothing to improve the economy but has created huge inequities and the
inefficient employment of capital that will have to be corrected at some time. The questions are when? and from what level?
All that said,
the whole circus revolving around the government shutdown and the negotiations
over the debt ceiling gives the Fed an excuse not to begin the process of
transitioning from easy to tight money.
Indeed, in a worse case scenario [government default], QEInfinity could
go on for as far as the eye can see.
However, that would change none of the above argument: sooner or later,
the Fed has to transition and the bigger its balance sheet, the harder it will
be to do it successfully and the greater the risk to the economy.
The new normalization of Fed policy
(medium):
(4) a blow up in the Middle East . While the carnage in Syria
continues, that is not the current problem.
The issue now is does Obama let the Iranians lure Him into to some deal
that enhances His world leadership role but only in His own mind while they
drive for the hoop [nuclear bomb]. The
immediate risk is less about Obama jerking Himself off [again] and more about
the Israeli’s now feeling isolated and taking matters into their own
hands.
(5) finally,
the sovereign and bank debt crisis in Europe . Economic conditions continue to improve in Europe. This progress likely moderates somewhat the
risk of a crisis as rising tax revenue make sovereign debt service more
manageable which in turn strengthens bank balance sheets [since a huge
percentage of their assets are in their own country’s sovereign debt].
The wild card
at the moment is that with the German elections out of the way, how will Merkel
respond to the renewed effort by eurocrats to salvage the economies, governments
and banks of southern Europe ? This doesn’t necessarily have to be a
negative. However, it is an unknown
which will likely return to the front pages.
Bottom line: the US
economy continues to grow but at a sub par rate. Fiscal policy remains a headwind. While the current effort by the GOP on the
continuing resolution/debt ceiling debates appears noble, in the end, there
will likely be little movement toward lower spending, tax reform and less
regulation until the present crowd in DC is replaced.
Monetary policy is
a huge negative and is apt to get worse in as much as a lousy fiscal policy
gives the Fed doves carte blanche to continue its lousy monetary policy. This factor is the major risk to our
forecast. The longer QEInfinity goes on,
the greater the risk that the transition from easy to tight money will cause
severe dislocations.
This all fits
our Model of a sluggishly growing economy restrained by too much spending, too
high taxes, too much regulation and a completely dysfunctional monetary policy
that has led to the misallocation of capital, the mispricing of assets and the
sacrifice of Main Street
savings in favor of bankster speculation.
At the moment, the biggest risk to our forecast is the unintended
consequences of this irresponsible Fed policy.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications fell,
(2)
consumer: weekly retail sales were up; September
vehicle sales were below forecasts; the September ADP
private payroll report was disappointing; jobless claims rose less than
forecast,
(3)
industry: the September ISM manufacturing index was
ahead of estimates while the nonmanufacturing index fell short; the September
Chicago PMI came above expectations; the
September Dallas Fed manufacturing index was much stronger than anticipated;
the September Markit PMI was in line,
(4)
macroeconomic: none.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15072, S&P 1690) drifted lower on worries about the government
shutdown/debt ceiling problems. The Dow ended in a short term trading range
(14190-15550) and below its 50 day moving average. On Thursday, the S&P broke below both its
short term uptrend (1679-1833) and its 50 day moving average; then rebounded
nicely on Friday, negating those breaks.
That leaves the indices are out of sync on a short term basis and the
Market directionless.
Both of the
Averages are well within their intermediate term (14971-19971, 1591-2177) and
long term uptrends (4918-17000, 715-1800).
Volume on Friday
was anemic though breadth improved. The
VIX fell 5%; but for all intents and purposes, this indicator has been flat
since the first of the year (short term trading range). Nevertheless, it is also firmly within its
intermediate term downtrend.
The long bond
was down slightly on Friday and closed within a short term trading range and an
intermediate term downtrend.
GLD moved lower,
unable to break out of a very short term, short term and intermediate term
downtrend. Nothing to do here.
Bottom line: the Averages out of sync on a short term
basis. They are also oversold, so a
continuation of Friday’s bounce would not surprise me. I continue to believe that this is a time to
do nothing unless you are skilled trader.
The exception being if one of our stocks trades into its Sell
Half Range
Fewer
stocks in uptrends (this supports our internal indicator):
Citi
joins the group of worriers (medium):
Here
is a particularly bearish take (medium):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15072)
finished this week about 30.4% above Fair Value (11550) while the S&P (1690)
closed 18.0% overvalued (1432). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe.
Most of the
assumptions in the above forecast are tracking our expectations: (1) the
economy continues to plod along, (2) the ruling class continues to entertain
the world with their budget resolution/debt ceiling antics; though, I believe
that in the end they will do just enough to keep from driving off the cliff,
(3) Europe is improving the odds that it will
‘muddle through’ and (4) the Fed gives me heartburn, having gained the
status of being the biggest risk to our outlook.
One of the
things that makes me nervous right now is (2) above. The investment world seems to think that the
shutdown/debt ceiling problems will be resolved before any real economic damage
is done; and the pin action supports that notion. As you know, that is my best guess. What spawns my concern is that all too often
the Market sets up to disappoint the maximum number of investors---and if
anything would take the Market by surprise right now, it would be a stalemate. This is not a prediction on either the
outcome of our fiscal problems or Market direction. It is a reflection of my compulsion to always
be worried about something. In this
case, it is concern about the economy; the Market could use some adjustment.
Bottom line: the assumptions in our Economic and Valuation
Models haven’t changed. Economic events
appear to be tracking much as we expected with the exception of monetary policy
which has become the biggest risk to our forecast. I remain confident in the Fair Values generated
by our Valuation Model---meaning that stocks are overvalued, so our Portfolios
maintain their above average cash position.
Any move to higher levels would encourage more trimming of their equity
positions.
This week, our Portfolios did nothing.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 10/31/13 11550 1432
Close this
week 15258 1691
Over Valuation vs. 9/30 Close
5% overvalued 12127 1503
10%
overvalued 12705 1575
15%
overvalued 13282 1646
20%
overvalued 13860 1718
25%
overvalued 14437 1790
30%
overvalued 15015 1861
35%
overvalued 15592 1933
Under Valuation vs.9/30 Close
5%
undervalued 10972 1360
10%undervalued 10395 1288
15%undervalued 9817 1217
* 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
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years with
somewhat higher inflation.
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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