Saturday, January 18, 2014

The Closing Bell

The Closing Bell

1/18/14

As you know, a project of mine has been to investigate not only how one gets assets out of this country but also how one gets oneself out of this country and where to go.  We have already looked at Panama (no); and this Friday, we are going to Costa Rica and will gone for a week.  As always, I will have my computer and if any action is required communicate via Subscriber Alert.

Statistical Summary

   Current Economic Forecast

           
            2013

Real Growth in Gross Domestic Product:                    +1.0-+2.0
                        Inflation (revised):                                                           1.5-2.5
Growth in Corporate Profits:                                            0-7%

            2014 estimates

                        Real Growth in Gross Domestic Product                   +1.5-+2.5
                        Inflation (revised)                                                          1.5-2.5
                        Corporate Profits                                                            5-10%

   Current Market Forecast
           
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Uptrend                               15790-20790
Intermediate Uptrend                              15790-20790
Long Term Trading Range                       5050-17400
                                               
                        2013    Year End Fair Value                                   11590-11610

                   2014    Year End Fair Value                                   11800-12000                                          

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     1792-1945
                                    Intermediate Term Uptrend                       1685-2366
           
                                    Long Term Trading Range                         728-1900
                                                           
                        2013    Year End Fair Value                                    1430-1450

                        2014   Year End Fair Value                                     1470-1490         

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                          43%
            High Yield Portfolio                                     46%
            Aggressive Growth Portfolio                        46%

Economics/Politics
           
The economy is a modest positive for Your Money.   This week’s economic data was again fairly upbeat: positives---mortgage and purchase applications, small business confidence, November business inventories and sales, the NY and Philadelphia Fed manufacturing indices, capacity utilization and the December Treasury surplus; negatives---PPI, ex food and energy, December housing permits and January consumer sentiment; neutral---weekly retail sales, weekly jobless claims, the December/November revisions of retail sales, PPI, CPI, housing starts, industrial production and the latest Fed Beige Book. 

The important numbers this week, in my opinion, were retail sales.   December stats looked good but were helped considerably by big November downward revisions.  Combined with the very mixed individual company reports and guidelines, I found the totality very confusing---though they were much better received by the Market.  This follows a week in which the employment data was just as confusing. 

If the remainder of the economic reports in both weeks hadn’t been generally positive, I would characterized the uncertainty in the numbers of these two key indicators as disconcerting at best.  For the moment, I leave our forecast in tact but simply point out that the employment and sales stats raise questions about the strength of the current uptrend:

‘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.’
                       
            Update on big four economic indicators:

        The pluses:

(1)   our improving energy picture.  The US is awash in cheap, clean burning natural gas.... In addition to making home heating more affordable, low cost, abundant energy serves to draw those manufacturers back to the US who are facing rising foreign labor costs and relying on energy resources that carry negative political risks.


       The negatives:

(1) a vulnerable global banking system.  Another week and more examples of malfeasance---this time traders front running GSE [government sponsored enterprises, e.g. Fannie Mae] orders, you would think that the banksters would have run out of ideas about how to screw the public by now.  Ah, but for the ingenuity of greed,

In addition, Fed bank regulators decided to alter the provisions of the Volcker Rule so that small banks could avoid recognizing losses [$600 million] on their balance sheets.  How much more of this crap is owned globally? And how much will ultimately have to be written off anyway? 

Not to be outdone, the ECB has lowered the capital requirements for its stress test (medium):  

Finally, as an illustration that the big banks are liars, thieves, actively circumvent regulators and are much less solvent than all the wild eyed optimists claims, HSBC just phonies up its books (medium):

Continuing trouble in China’s shadow banking industry (medium):

More on gold price fixing (medium):

‘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.  there were three positive developments this week [a] the senate and house passed a 2014 appropriations bill---the first in five years, [b] the December government budget was in surplus and [c] the proposal to extend unemployment benefits for an 11th time was defeated. 

I covered each of these in the Morning Calls this week.  So I will just give the bottom line: these are all positive and, at least on a short term basis, reduce the risk that a threat to our economy could come from this direction. 

That said, we can’t forget the recent demise of the sequester, the ongoing problems with Obamacare and His vows to use His pen to impose rules that can’t make it through the legislative process.  Until our ruling class comes to grips with the fact that government is the problem not the solution, fiscal policy will remain a risk and a headwind to economic growth.

And (short):

(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. 

Tapering for pussies is policy but the question is how much impact the recent confusing retail sales and employment data will have on that policy.  Any sign of a slowdown from an already anemic recovery could give ammunition to the Fed doves to slow the rate of the taper.

In any case, whatever the Fed does, we stuck with the key issues; [a] can the Fed successfully transition from easy to tight money without bungling the process---which it has done at every other such juncture in its history?  [b] from an economic standpoint, since QEInfinity had little effect on economic activity during its tenure, will it have an impact being unwound?  [c] from a Market standpoint, since asset prices are where the impact of QE has been felt the most, isn’t reasonable to assume that it is the Markets that will have to pay the price for the Fed’s monetary experiment. 

(4)   a blow up in the Middle East.  This week Iran and the group of five reached a tentative agreement on the Iranian nuclear program though there is some disagreement on its provisions.  The cynic in me says that the Iranians, with some help from others in the group of five, are playing Obama like a Stradivarius.  For all His good intentions, He has no experience playing international hardball, which He has proven on numerous times in the past, and His advisors are cut from the same hopey, feely, cumbayah bolt of cloth as He is.

I believe that increases the risk of [a] a miscalculation on Iran’s part---getting too aggressive [b] and/or that that Israel and one or more of the Gulf sunni muslim powers will take the job of restraining Iranian nuclear policy into their own hands.

Temporary Iranian agreement to begin January 20 (medium) 


(5)   finally, the sovereign and bank debt crisis in Europe.  The economic news out of Europe remained mixed this week.  My hope is that Europe is recovering in the same fashion as the US---slowly, fitfully but on a sustained basis.  That would allow our ‘muddle through’ scenario to remain in tact. 

Bottom line:  the economy continues to click along nicely despite this week’s confusing retail sales data.  However, this is the second week in a row in which the data of a key economic indicator has caused uncertainty.  I am not blowing the whistle yet, but another such week and the yellow light will be flashing. 

There was some good news on fiscal policy this week.  While it is a positive for the near term, fiscal irresponsibility for the long term remains a headwind.

The outcome of tapering for pussies is and will remain an unknown for some time.  Whether or not it proves successful depends on (1) if the Fed really proves effective in unwinding QE without causing economic disruptions and (2) how the Markets handle tapering for pussies under conditions of extreme valuation?

There was little out of Europe this week to alter our outlook which remains that it will ‘muddle through’.

This is an upbeat summary of the economy, but the author confuses a healthy economy with a fairly valued market (medium):

Counterpoint:

This week’s data:

(1)                                  housing: weekly mortgage and purchase applications were strong; December housing starts were down big, but in line; permits, however, were down big although estimates had been for an advance,

(2)                                  consumer:  weekly retail sales were mixed; December retail sales were ahead of estimates though November sales were revised down substantially; weekly jobless claims fell fractionally; the preliminary January University of Michigan index of consumer sentiment came in at 80.4 versus estimates of 83.5,

(3)                                  industry: while still at depressed levels, December small business confidence rose slightly more than expected; November industrial production was up, in line, capacity utilization was a touch better than anticipated, November business inventories were up, sales were up even more; the New York and Philadelphia Fed manufacturing indices were better than forecasts,

(4)                                  macroeconomic: the December US budget was in surplus; December PPI, CPI and CPI ex food and energy were in line; PPI ex food and energy was well above consensus; the latest Fed Beige Book reported continued economic improvement in in all areas of the country.
           
The Market-Disciplined Investing
           
  Technical

The indices (DJIA 16458, S&P 1838) had a trendless week, though they closed within uptrends along all timeframes: short term (15790-20790, 1782-1945), intermediate term (15790-20790, 1685-2266) and long term (5050-17400, 728-1900).

Volume was up on Friday, largely due to options expiration; breadth was mixed.  The VIX was down, ending very near the lower boundary of its short term trading range.  A break of this support level would be a big positive for stocks.  It is also in an intermediate term downtrend.    I should note that the fact that the VIX is now trading at a low level suggests a high level of investor confidence.

More on sentiment (short): 

The long Treasury continues its strong upward movement.  It remains in a short term trading range and an intermediate term downtrend.

GLD was also up big, trading through its 50 day moving average.  If it holds above this indicator at the close Tuesday, the break will be validated.  That is the third positive technical development in a row.  If it confirms the challenge to the 50 day moving average, our Portfolios will likely start to nibble.  However, it will be small given that GLD remains within its short and intermediate term downtrends. 

Bottom line:  all trends of both indices are up, although trading was schizophrenic this week, e.g. the Dow up, the S&P down on Friday.  That doesn’t mean stocks are heading lower.  Indeed, as I point out above, the very low level of the VIX suggests that investors still have a lot of confidence. 

On the other hand, it is worth recalling that the S&P broke to a new all time high this week, then immediately reversed itself. That sets up the potential of a double top.  But for that to happen, the S&P needs to trade below at least the 1815 level and 1792 to be really confident.

Those levels, of course, are a ways off; so until/unless that happens, the Market direction is up and the current target is the upper boundaries of the Averages long term uptrends (17400, 1900).

However, if one of our stocks trades into its Sell Half Range, our Portfolios will act accordingly.

The gold market has been quite strong of late, challenging its 50 day moving average on Friday.  A successful break above this indicator will likely cause our Portfolios to start to nibble.
               
   Fundamental-A Dividend Growth Investment Strategy

The DJIA (16458) finished this week about 41.5% above Fair Value (11625) while the S&P (1838) closed 27.3% overvalued (1443).  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.

The economy appears to be tracking our forecast, though last week’s confusing employment picture and this week’s retail data inject some unneeded uncertainty.  That doesn’t mean that the economy is rolling over, but if we get any more negative indications, I will be switching on the yellow warning light. 

Fiscal policy was a bit of a mixed bag this week.  The senate DK’d the extension of unemployment benefits, a budget was passed and December budget was in surplus.  On the other hand, Obama is threatening to do all in His power to correct ‘income inequality’ and the news on Obamacare hasn’t improved.  In short, the economy remains burdened with too much government spending, too high taxes, too much regulation and will continue to be until the ruling class understands that government is the problem not the solution.

Monetary policy is a mess; and given Bernanke’s defense of it on Thursday, I see little hope of improvement---leaving us stuck with the same old set on unknowns: (1) can the Fed manage a successful transition to tighter money? , and whether or not it does (2) what will be the impact on the economy? (3) what will be the impact on the Markets? and (4) will the Markets be patient enough to allow the Fed to execute its plan?

I don’t know the answer to those questions although history gives us a hint---and the consequences are not positive.

Bottom line: the assumptions in our Economic Model haven’t changed, though employment and retail sales data suggest that they might.

The assumptions in our Valuation Model have not changed either.  I remain confident in the Fair Values calculated---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.
   
That said, I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.
       
          This week our Portfolios did nothing.

        Subscriber Alert

          Finally, as you know, I have been doing work on developing an all ETF Portfolio.  Of late, I have felt confident enough that I have started committing money.  It hasn’t shown up on our website because we are in the process of revamping it. 

         The investment strategy of this ETF Portfolio is to invest in a board range of asset classes, providing a maximum of diversification.  There is 10 different asset classes (US REIT, Foreign REIT, US Tips, US Junk Bonds, US Bonds, Foreign Developed Markets Stocks, Foreign Junk Bonds, Foreign Developed Markets Government Bonds, Foreign Investment Grade Corporate Bonds, Foreign Government Inflation-linked Bonds, US Stocks, Emerging Market Stocks, Emerging Markets Government Bonds and Commodities), each position will be 10% of the Portfolio.

         The Portfolio has started making commitments.  First, in US quality municipal bond ETFs (substituting for US Bonds, US Tips and US Junk Bonds) which will eventually comprise 30% of the Portfolio.  The initial commitments were 20% of a normal position size.  I have elected to put this money in municipal bonds initially because (1) my tax status, but more importantly, (2) muni bonds have been crushed due to the problems in Detroit and Puerto Rico and (3) sectors for which I am substituting them are not nearly as depressed. 

            Currently, the ETF’s I have chosen yield 6.5-7%.  Bear in mind that is after tax return.  I believe strongly that there is no way stocks will provide a 6.5-7% annual return for the next 10 years from current price levels. Yes, I know everyone hates bonds and especially muni bonds.  But that is the point, these ETF are selling at the equivalent of a Buy Value Range.  Those ETF’s are: Blackstone Quality Municipal Trust (BKN), Nuveen Dividend Advantage Municipal Trust (NAD) and Nuveen Premium Income Municipal Trust (NPM).

      The Portfolio has also taken positions in Powershares Emerging Market Sovereign Debt (PCY) and Vanguard US REIT (VNQ).  Both are in asset classes that have been beaten up and are selling in the equivalent of a Buy Value Range.

       I will keep you posted on other purchases.  Hopefully, our new site will be up and running soon.
       
DJIA                                                   S&P

Current 2014 Year End Fair Value*              11900                                                  1480
Fair Value as of 1/31/14                                  11625                                                  1443
Close this week                                               16458                                                  1838

Over Valuation vs. 1/31 Close
              5% overvalued                                12206                                                    1515
            10% overvalued                                12787                                                   1587 
            15% overvalued                             13368                                                      1659
            20% overvalued                                13950                                                    1731   
            25% overvalued                                  14531                                                  1803   
            30% overvalued                                  15112                                                  1875
            35% overvalued                                  15693                                                  1948
            40% overvalued                                  16275                                                  2020
            45%overvalued                                   16856                                                  2092

Under Valuation vs.1/31 Close
            5% undervalued                             11043                                                    1370
10%undervalued                                10462                                                  1298   
15%undervalued                             9881                                                    1226

* 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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