Saturday, December 6, 2014

The Closing Bell--12/6/14

The Closing Bell


Statistical Summary

   Current Economic Forecast


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%

            2015 estimates

Real Growth in Gross Domestic Product                   +2.0-+3.0
                        Inflation (revised)                                                          1.5-2.5
                        Corporate Profits                                                            5-10%

   Current Market Forecast
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Uptrend                                 16164-18910
Intermediate Term Uptrend                      16135-21100
Long Term Uptrend                                  5369-18960
                        2013    Year End Fair Value                                   11590-11610

                        2014    Year End Fair Value                             11800-12000                                          

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     1862-2226
                                    Intermediate Term Uptrend                       1704-2420
                                    Long Term Uptrend                                    783-2071
                        2013    Year End Fair Value                                    1430-1450

                        2014   Year End Fair Value                                     1470-1490         

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                          47%
            High Yield Portfolio                                     53%
            Aggressive Growth Portfolio                        49%

The economy is a modest positive for Your Money.   This week’s economic data was abundant and again weighed to the plus side: positives---weekly purchase applications, November light vehicle sales, weekly jobless claims, the ISM manufacturing and nonmanufacturing indices, October construction spending, unit labor costs, the latest Fed Beige Book and November nonfarm payrolls; negatives---mortgage applications, Cyber Monday sales,  October consumer credit, November ADP private payrolls, the November Markit services PMI, October factory orders, third quarter nonfarm productivity and the October trade deficit; neutral---weekly retail sales.

There were five primary indicators reported (both ISM numbers, construction spending, factory orders and nonfarm payrolls); all but one came in positive.  This is a further step in minimizing the really lousy reports we received two weeks ago.  So the preponderance of both the overall positive stats as well as the primary indicators not only is in line with our forecast but provides another reason to dismiss the aforementioned disappointing week’s data.

On the other hand, the numbers from overseas just keep getting worse as do the prognostications for 2015. So in short, our outlook remains the same, and the primary risk (the spillover of a global economic slowdown) remains just so.

Our forecast:

 ‘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, the weakening in the global economic outlook, 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 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.

‘Unfortunately, this positive in our outlook may be getting to be ‘too much of a good thing’.  Whether because of new abundant supplies or falling demand, the price of oil has been getting hammered of late; and sooner or later this plus could become a minus.’

‘I have no idea where the crossover point is, but there is one in which the positive created by lower prices to consumer and industry is offset by losses in employment and weakening corporate financial structures resulting from decreased drilling activity (remember the energy industry has been a major contributor to job growth and cap ex spending).’

       The negatives:

(1)   a vulnerable global banking system.   This week’s menu of bankster activity includes Citi closing down its ‘dark pool’ fund [this is actually good news].  But JP Morgan made the headlines again---this time for hiring a man that claimed on his resume that he knew how to scam the electricity futures market.

Citi shutters fifth largest ‘dark pool’ fund (medium):

No post is worth its salt without at least one example of JP Morgan crimes (medium):

And still no one goes to jail (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. Not much occurred this week; but the issue of government funding itself is just around the corner.  I don’t think that the GOP will use it to bludgeon Obama; but I also don’t believe that they will agree to finance all of FY2015.  How they resolve this dilemma will make interesting reading.

David Stockman on the federal debt and budget deficit (medium):
(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. 

This week:

(1)   the ECB left interest rates unchanged; but Draghi said that QE is not far away.  I am not convinced that the German’s will allow him to keep that promise,

Goldman on Draghi’s [ECB] latest statement (medium):

(2)   China followed its recent rate cut by joining the QE club.  That leaves the QE carnival with lots juice, especially if the Chinese get jiggy with it.  Undoubtedly, the hedge funds, carry traders and yield chasers are ecstatic. 

Most economists are also applauding, though I haven’t a clue as to why.  It hasn’t worked in the US or Japan.  On the other hand, it has allowed the politicians to avoid making the tough fiscal decisions that would likely pull us and the rest of the world out of our malaise [tax and regulatory reform].  The question is, even if the central bankers suddenly found religion and turned the pumps off, is it too late to salvage the overregulated, overtaxed, overleveraged economies without a recession?

David Stockman on Fed policy (medium/long and today’s must read):

More on Fed policy (medium):

(3)   geopolitical risks.  Relative quiet this week although [a] OPEC’s {the Saudi’s} decision to not cut production could have potentially significant implications if the cash flow negative members of OPEC get desperate and [b] the US is sending additional arms to NATO members bordering Russia.  Despite this comparative calm, this is the source of a potential exogenous factor that could produce the loudest bang.

(4)    economic difficulties, overly indebted sovereigns and overleveraged banks in Europe and around the globe.  The economies of the rest of the world continued to deteriorate this week: the EU October manufacturing PMI, the flash services PMI and the composite PMI were all down and the October manufacturing number was revised lower, the Chinese manufacturing PMI declined to an eight month low, Russia forecast that its 2015 GDP would be down, Germany lowered its 2015 outlook for growth and Moody’s downgraded Japan’s credit rating. 

I have no idea when, as and if the rest of the globe’s worsening economic straits will ever wash on to our shores; but I do know that there is a clear risk of it happening; so this remains the biggest risk to our forecast.

Bottom line:  the US economic news showed a further bounce back from the week before last’s horrible data.  I view that as a positive for our outlook of a struggling albeit growing economy.  Perhaps more important, the advance continues strong enough to withstand any negative fallout from a slowing world economy---which showed more signs of slowing this week. 

What is coming next is going to hurt (medium):

China joined the QE crowd this week.  While I am unsure of the magnitude of its easing, anything will contribute to more short term liquidity, more asset mispricing and a greater mean reversion when it finally occurs.  In addition, Draghi promised QE once again, though I continue to believe that this is all talk and no do.

On the geopolitical front, there was little news this week.  While the odds of a disastrous exogenous event occurring may be small, the magnitude of the consequences of such an event could be enormous.

This week’s data:

(1)                                  housing: weekly mortgage applications declined but purchase applications were up,

(2)                                  consumer:  weekly retail sales were mixed; Cyber Monday sales were about half of forecasts; November light vehicle sales were encouraging; weekly jobless claims fell, in line; November nonfarm payrolls were much better than expected; November ADP private payrolls grew less than consensus, October consumer credit grew less than estimates,

(3)                                  industry: the November Markit manufacturing PMI slightly below forecasts while the November ISM manufacturing and non-manufacturing indices was better than anticipated; October construction spending rose much more than expected, October factory orders were disappointing,

(4)                                  macroeconomic: third quarter nonfarm productivity rose less than consensus and unit labor costs fell 1.0% much more than estimates; the latest Fed Beige Book was generally upbeat; the October trade deficit was more than anticipated.

The Market-Disciplined Investing

            The Dow (17958) closed the week above its 50 day moving average and within uptrends across all timeframes: short term (16164-18910), intermediate term (16135-21100) and long term (5369-18960). 

The S&P (2075) finished slightly above the upper boundary of its long term uptrend (783-2071) for the third day.  If it remains above that boundary through the close on Wednesday, the break will be confirmed.  However, each day of its boundary violation has been ever so slight.  If it continues to merely surf the upper boundary, the break clearly won’t be decisive.  It really requires strong follow through to cement the notion of a successful challenge.  The S&P finished within its short term (1862-2226) and intermediate term (1704-2420) uptrends and above its 50 day moving average.

Volume rose on Friday; breadth improved. The VIX fell, having re-set to a trading range on Thursday (a plus for stocks).  It continued within its intermediate term downtrend and below its 50 day moving average.   
The long Treasury was off on Friday but it is still in position to challenge the upper boundary of its very short term trading range.  It remained within its short term uptrend, its intermediate term trading range and above its 50 day moving average.  Nothing about this pin action suggests a stronger economy.

GLD fell on Friday, closing right on the lower boundary of its former long term trading range (having been above that boundary 11 out of the last 14 trading days).  I think it remains to be determined whether the initial break was real or a false flag and whether that boundary will end up marking the effective bottom for GLD.  That said, the fact that it is in downtrends across all timeframes and below its 50 day moving average suggests the former alternative.

Bottom line: the S&P is challenging the upper boundary of its long term uptrend but not very forcefully.  Indeed as long as remains within a couple of points (as it has done the last three trading days), it is going to be hard to convince me that this is a break at all.  I will make the call but I won’t believe it until there is follow through to the upside. 

TLT continues to toy with the upper boundary of its very short term trading range and to demonstrate upside momentum.  GLD likewise is struggling with a boundary---the former lower boundary of its long term trading range but has all the technicals working against it.  Neither of these charts suggest a stronger economy.  On the other hand, the break down in the VIX is consistent with an improving stock market.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (17958) finished this week about 50.9% above Fair Value (11900) while the S&P (2075) closed 40.2% overvalued (1480).  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, Japan and China.

Following a rough set of numbers two weeks ago, the US economic data appears to be back on track.  The Market was particularly ebullient over Friday’s nonfarm payroll number---which is, as you know, good economic news but which, as you also know, should be bad news for Fed policy.

Of course for the last year, we have, for the most part, been in an environment where good news (a better economy) is good Market news and bad news (a weakening economy) is good Market news (continuing Fed ease).  At some point in time, investors’ infinite jigginess is going to give way to the notion that bad news is indeed bad news. Could be tomorrow or next year or the next year.  But it is going to occur.  At that point, then the risk of declining growth/recession/deflation occurring overseas becomes of even more importance.

Speaking of the global economy, it continues to go from bad to worse.  The latest stats, noted above, were virtually all negative.  We have to give credit to the US economy for continuing to advance when the rest of the world is suffering.  The $64,000 question is, how long can it continue to do so?

QE got a boost this week from additional easing measures by the Chinese central bank.  As I noted above, I am not sure of its magnitude; but in investors’ minds something is clearly better than nothing.  Further, Draghi made more promises on QE (but did nothing). Nonetheless, QEInfinity is alive and well and investors are loving it---witness the steady climb in equity prices.  The only issues are what happens when it stops or what happens if it doesn’t stop?  In other words, in my opinion, this is a lose/lose equation.

Oil (prices) was the main headline this week with a majority of the pundits predicting that they will go lower and that this trend is a big positive to the US economy.  I always get nervous when the experts agree on the direction and consequences of a developing trend especially one that is so impactful on our economy---like oil.  I am not deliberating trying to invent negatives here; but my point is that the US economy is far too complex for such an overwhelming consensus; plus there are invariably unknown unknowns involved when a major sector of the economy is disrupted.  So I caution not to get too jiggy.



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 improvement in the current scenario (improved economic growth, responsible fiscal policy, successful monetary policy transition) that gets valuations to Friday’s closing price levels. 

Bottom line: the assumptions in our Economic Model haven’t changed (though our global ‘muddle through’ scenario is at risk).  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.

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.
            The latest from Lance Roberts (medium):

DJIA                                                   S&P

Current 2014 Year End Fair Value*              11900                                                  1480
Fair Value as of 12/31/14                                11900                                                  1480
Close this week                                               17912                                                  2074

Over Valuation vs. 12/31 Close
              5% overvalued                                12495                                                    1554
            10% overvalued                                13090                                                   1628 
            15% overvalued                                13685                                                    1702
            20% overvalued                                14280                                                    1776   
            25% overvalued                                  14875                                                  1850   
            30% overvalued                                  15470                                                  1924
            35% overvalued                                  16065                                                  1998
            40% overvalued                                  16660                                                  2072
            45%overvalued                                   17255                                                  2146
            50%overvalued                                   17850                                                  2220

Under Valuation vs. 12/31 Close
            5% undervalued                             11305                                                      1406
10%undervalued                            10710                                                       1332   
15%undervalued                            10115                                                  1258

* 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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