Friday, July 25, 2014

The Morning Call--Good news and bad news

The Morning Call

7/25/14

The Market
           
    Technical

            The indices (DJIA 17083, S&P 1987) had another mixed performance (Dow down, S&P up) yesterday.  They remained above their 50 day moving averages and within uptrends across all time frames: short (16232-17711, 1916-2082), intermediate (16593-20891, 1858-2658) and long (5083-18464, 762-1999). 

            Volume fell; breadth worsened.  The VIX rose, finishing below its 50 day moving average and within short and intermediate term downtrends.

            The long Treasury fell.  While it reset to a short term uptrend Wednesday, it dropped enough to place it back below the upper boundary of its former short term trading range.  This is a continuation of the recent schizophrenic TLT pin action.  I want to see some follow through before reversing the re-set call.  Whether that happens or not, clearly bond investors currently lack certainty regarding the economic outlook.  As you know, this is the same affliction that we experienced in our recent abortive GLD trade.

            GLD declined big, closing below its 50 day moving average for the first in over a month.  It remains within a short term trading range and an intermediate term downtrend.

Bottom line: the confusion we have witnessed in the gold and now the Treasury markets goes hand in hand with the growing divergences within the equities market.  However, I don’t have to tell you that to date that has meant nothing with regard to the performance of the Averages.  In the end though, it doesn’t matter.  If a majority of stocks are declining, then the overall market is reflecting the aforementioned confusion and divergences. 

The $64,000 question is, will an exogenous event occur that suddenly pushes all valuations back to more normal levels or will it dissipate the confusion and divergences allowing the rest of stock market to catch up with the Averages.  You know my answer; but so far, that opinion has been worth zip.

Our strategy remains to do nothing save taking advantage of the current momentum to lighten up on stocks whose prices are pushed into their Sell Half Range or whose underlying company’s fundamentals have deteriorated.

            Another divergence (short):

            More on junk bond price action (medium):

            Update on sentiment (short):

    Fundamental

         Headlines

            Yesterday’s US dataflow held some really good news---weekly jobless claims and the Kansas City Fed manufacturing index---and some really bad news---the Markit flash PMI and new housing starts.  Of the four stats, the jobless claims and new housing starts were the most important---which still leaves us with a mixed picture.   However, I remind you that employment is a lagging indicator; so it is not inconsistent to have improving employment as the economy is rolling over.  On the other hand, this series of datapoints could just be more of the same erratic flow that has characterized this entire recovery.  So I am not making a recession call; I am suggesting that these stats can be explained by two dramatically different scenarios.

            Overseas, we got more good news: the flash PMI’s of both China and the EU were above expectations; and they were quite welcome after a long string of subpar economic reports.  Offsetting that was another terrible trade number out of Japan.  I would like to see some follow through in improving Chinese and European economic data before getting too jiggy.

            Two additional news items are worth mentioning:

(1)   the former CEO of Banco Espirito Santo has been detained on allegations of money laundering.  Another example that the regulatory environment in the EU is just as promiscuous  as it is here, reinforcing my concerns about some kind of financial calamity within an overleveraged banking system (medium):

(2)   Russian oligarchs are reacting to the threat of UK sanctions by pulling their money out of London---ooops.  Whether or not this gives British or the rest of the EU pause in following Obama’s lead in imposing sanctions on Russia remains to be seen (short):

                        Accusations flew in both directions overnight (short):

Bottom line: while yesterday’s better employment numbers were welcome, they could have a perverse impact---since (1) it is the employment stats that Yellen says that she is focused on and that will have a significant effect on the decision to raise interest rates and (2) historically, markets have not reacted positively to Fed tightening. 

On the other hand, new housing starts are another in a string of poor reports out of the primary sectors on the economy.  That keeps alive the risk of our recovery becoming even weaker than it already is.  If that were to happen, it raises the possibility of the Fed raising rates based on better employment while the economy is rolling over which would only make any downturn worse.

Of course, everything could just keep coming up roses and stocks could reach new historic highs while the unicorns frolic with the nymphets.  Oh to be there, fully invested, with a fifth of Glenmorangie and adorned with only a fig leaf (and single and 30 years younger).   

My bottom line is that for current prices to hold, it requires a perfect outcome to the numerous problems facing the US and global economies AND investor willingness to accept the compression of future potential returns into current prices.

 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.

            Bear in mind, this is not a recommendation to run for the hills.  Our Portfolios are still 55-60% invested and their cash position is a function of individual stocks either hitting their Sell Half Prices or their underlying company failing to meet the requisite minimum financial criteria needed for inclusion in our Universe.
        
            It is a cautionary note not to chase this rally.

            Update on Buffett’s favorite valuation metric (short):

            The Fed keeps the bubble expanding (short):

            The latest from Lance Roberts (medium):

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