The Closing Bell
2/8/14
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 Trading Range 15330-16601
Intermediate Uptrend 14696-16601
Long Term Uptrend 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 Trading Range 1746-1858
Intermediate
Term Uptrend 1705-2385
Long Term Uptrend 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 turned a bit more mixed than in the recent past: positives---mortgage
applications, weekly jobless claims, the January ADP private payroll report,
the January ISM nonmanufacturing index, December construction spending and
fourth quarter productivity and unit labor costs; negatives---weekly purchase
applications, January light vehicle sales, January retail chain store sales,
January nonfarm payrolls, December Markit PMI, January ISM manufacturing index
and the December trade deficit; neutral---weekly retail sales, and December
factory orders.
The important
numbers this week were (1) the ISM manufacturing index because in adds a poor
number from the business sector to the already uncertain data on retail sales
and employment and (2) the employment reports because they were again
confusing. All in all, the dataflow,
particularly the primary stats of major GDP sectors, is getting more worrisome.
And:
In this whole
mix of uncertainty, economists and investors are also attempting to factor in two
somewhat contradictory factors:
(1) on the
negative side, economic and political turmoil in the emerging market have been
exacerbating fears on a weak US economy---the concern being that a slowdown in
growth there would raise the risk of recession here. To be sure, they pose a risk. However, the problems in the emerging markets
have been around for eight or nine months and until lately were largely ignored
as irrelevant. So there is really no new
news there. Nonetheless, psychology being what it is, the EM difficulties have
now taken on more importance in investors’ minds. Whether or not their difficulties ultimately
impact the US economy remains to be seen.
(2)
weather. No doubt, it has been a rough
winter so far. The optimists are
insisting that sales, employment and ISM data are tainted by this factor and,
hence, there is no reason to question the underlying strength of the
economy. I must say that I have some
sympathy with this argument. The real question
though, is the weather aggravating an already slowing economy. Clearly, we won’t know that for a while.
So we clearly
are in a period in which the economic outlook has become a bit more opaque. That said, it should be remembered that we
have experienced several brief soft patches in economic stats during the
current recovery with no lasting effects.
Hence, I remain of the opinion that it is too soon to be altering our forecast;
but with Friday’s disappointing nonfarm payrolls report, I am turning on the
yellow warning light. For the moment,
our forecast remains:
‘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.
What is a week without another negative headline on JP Morgan [our
fortress bank] misdeeds?
In addition,
the regulators are now closing in on currency manipulation charges (short):
‘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. It
was business as usual for our ruling class this week: [a] Obama is raising the
minimum wage for all federal contractors by executive order, [b] congress is in
the final stages of passing an outrageously expensive Farm Bill that lines the
pockets of corporate farmers, [c] the anecdotal evidence of Obamacare failures
keeps growing, while [d] the CBO put a fine point on the macroeconomic
consequences, forecasting higher unemployment and increased deficits as a
result.
None of this
suggests that Washington [and by that I mean both parties] is any closer to
understanding the burden that its rules, regulations and taxes are placing on
the economy. Until it does, fiscal
policy will remain a risk and a headwind to economic growth.
And:
As a post
script, late yesterday afternoon, Treasury Secretary Lew announced that the
debt ceiling will be hit in late February.
In an election year and with the GOP now having the dems on the run over
Obamacare, I can’t fathom that extending the debt ceiling will be the same
brouhaha that it has been the last couple of times. While I would love to see the republicans
continue to make an issue of it, which is not likely to happen for obvious
political reasons. But with this group
of yahoos, you never know.
(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, employment and manufacturing data along with the continuing
turmoil in the emerging markets will have on that policy. Clearly, there is enough uncertain data out
there to provide an excuse for the Fed to ease back on tapering. If it does, then we are back on the same old
treadmill, only the subsequent renewed tapering will start from even loftier
levels.
If not, then the
key issues remain: [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.
A
must read article from Barry Ritholtz on misguided Fed policy (medium):
(4)
a blow up in the Middle East . No one has blown anyone else up this week. So things are quiet. That said, rumors are flying about potential
terrorists attacks on the participants or spectators to the Sochi Olympics.
This could be a wild card next week.
(5) finally,
the sovereign and bank debt crisis in Europe . I suppose I could expand this risk to include
the emerging markets; but as noted above, their problems have been well
documented over the last eight to nine months---with little visible impact on
the developed economies.
Not to dismiss
this issue out of hand, one instance where problems could arise is in the
developed markets financial systems if, for example, Argentina or Venezuela
goes toes up and one of the EU banks [Spain] has too much of that country’s
debt. It could potentially tip a bank
with an already overleveraged balance sheet containing too much sovereign junk
over the edge.
That said, the
ECB’s decision this week to leave interest rates unchanged suggests that there
is institutional confidence that the EU’s constituent economies and financial system
are in reasonable shape. I recognize
that it could be dangerous to accept this assumption at face value [see link
below]. But until there is some change
in the dataflow, I am sticking with the ‘muddle through’ scenario.
Bottom line: the economy continues to grow sluggishly
though the data has become a bit more ambivalent. I do believe that some of the shortfall in
expectations can be attributed to weather; I am just not sure how much. For the moment, I leave our forecast
unchanged; though, as I noted above, I have turned on the flashing yellow light.
Washington
returned to its old fiscally irresponsible, overly enthralled with regulation
self (Farm Bill, minimum wage) this week.
These guys remain one of the major obstacles to long term economic
growth.
The outcome of
tapering for pussies is and will remain an unknown for some time. Whether or not it is successful depends on (1)
if the Fed really proves effective in unwinding QE without causing economic
disruptions---an immediate test coming from any Fed reaction to the increase
uncertainty in the economic data, 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 week’s
data:
(1)
housing: weekly mortgage applications rose while
purchase applications fell,
(2)
consumer: weekly
retail sales were mixed while January chain store sales fell; January light
vehicle sales were disappointing; weekly jobless claims dropped more than
consensus; the January ADP private payrolls were up but below recent levels;
and January nonfarm payrolls were lower than anticipated,
(3)
industry: the December Markit PMI was slightly below expectations;
the January ISM manufacturing index was well below estimates while the
nonmanufacturing index came in as anticipated; December construction spending
was a tad over forecast; December factory orders were down but less than
consensus,
(4)
macroeconomic: the December trade deficit was larger
than expected; fourth quarter nonfarm productivity and unit labor costs were
better than forecast.
The Market-Disciplined Investing
Technical
The indices (DJIA
15794, S&P 1797) had a roller coaster week.
After a pounding on Monday, they recovered later in the week. Both closed within short term trading ranges
(15330-16601, 1786-1858). They are out
of sync on their intermediate term trends---the Dow in a trading range (14696-16601
and the S&P in an uptrend (1705-2485).
Long term, they are in uptrends (5050-17400, 728-1900).
Volume was flat on
Friday and has been low for the entire rally this week; breadth was mixed. The VIX was down, ending within its short term
trading range and intermediate term downtrend.
The long Treasury
was up fractionally, finishing within a now wider short term trading range and
an intermediate term downtrend.
GLD was rose,
but remains within both short and intermediate term downtrends. It is trying to break the upper boundary of
another very short term downtrend.
However of late, it has had such a lousy record of follow through after penetrating
resistance levels, I am not sure how jiggy to be if that occurs.
Bottom line: the bulls clearly still have mojo, recovering as
they did from a drubbing on Monday and then rallying and even spiking on Friday
following a lousy nonfarm payroll number.
However, volume on the rally was low and breadth mixed---not
particularly reassuring for the optimists.
In addition, the short term uptrends of both Averages have been taken
out as has the intermediate term uptrend of the Dow. So just as clearly, some technical damage has
been done.
I have no idea whether
or not the current correction is just some consolidation or is part of a
topping process (remember Market tops are processes, not just a suddenly
reversal that characterizes bottoms). I continue
to think that a potential deciding signal, if it were to occur, would be a
breakdown of the S&P through the lower boundary of its intermediate term
uptrend. If it can hold above, then that likely means
that the long term momentum is still to the upside and the old highs will
probably be challenged at the very least; if not, then it could mark an end to
a topping process.
Meanwhile, we
have a Market in a trading range; so there is really not much to do save using
any price strength that pushes one of our stocks trades into its Sell Half
Range to act accordingly.
Technical
thoughts from Citi (medium):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15794)
finished this week about 35.5% above Fair Value (11650) while the S&P (1797)
closed 24.2% overvalued (1446). 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 recent confusing
dataflow, particularly in the primary sectors of the economy, has raised
questions regarding the sustainability of the current recovery. Weather is being argued as a major mitigating
factor; and I tend to agree with this analysis.
Nevertheless, the lousy numbers can’t be summarily dismissed. So the caution flag is out.
Our ruling class
continues to act as if its only responsibility is to itself and its own
re-election---the Farm Bill, Obamacare and the hike in the minimum wage being
just the latest examples. As such they
and their fiscal policy (too much government spending, too high taxes, and too
much regulation) remain an anchor tied around the throat of the economy.
The recent signs
of economic weakness raise an interesting question with respect to monetary
policy: will a dovish Fed use these numbers as an excuse to taper the tapering
and amplify the already extreme policy measures that it has taken since 2007 to
stimulate the economy? To do so in my
opinion would be a major negative and would only magnify the risks associated
with unwinding its massive balance sheet: (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?
Overriding all
of these considerations is the cold hard fact that stocks are considerably overvalued
not just in our Model but with numerous other historical measures which I have
documented at length. This overvaluation
is of such a magnitude that it almost doesn’t matter what occurs fundamentally,
because there is virtually no scenario (improved economic growth, responsible
fiscal policy, successful monetary policy transition) that gets valuations to
current price levels. Said another way,
we could get nothing but good news from here and that wouldn’t prevent losses
in equities when, as and if they finally return to mean historical values.
Bottom line: the
assumptions in our Economic Model haven’t changed, though the risks are rising
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 the Dividend Growth
Portfolio Sold is position in Target (TGT).
This seasons earnings and
revenue ‘beat’ rates (short):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 2/28/14 11650 1446
Close this week 15794 1797
Over Valuation vs. 2/28 Close
5% overvalued 12232 1518
10%
overvalued 12815 1590
15%
overvalued 13397 1662
20%
overvalued 13980 1734
25%
overvalued 14562 1806
30%
overvalued 15145 1878
35%
overvalued 15727 1951
40%
overvalued 16310 2023
45%overvalued 16892 2095
Under Valuation vs. 2/28 Close
5%
undervalued 11067 1373
10%undervalued 10485
1301
15%undervalued 9902 1229
15%undervalued 9902 1229
* 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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