The Closing Bell
1/17/15
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%
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 16394-19164
Intermediate Term Uptrend 16443-21608
Long Term Uptrend 5369-18960
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short Term Uptrend 1902-2283
Intermediate
Term Uptrend 1729-2443
Long Term Uptrend 783-2083
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 49%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 51%
Economics/Politics
The
economy is a modest positive for Your Money. The US
economic data this week was mixed: positives---weekly mortgage and purchase
applications, weekly retail sales, the January NY Fed manufacturing index,
preliminary January consumer sentiment and the December small business optimism
index; negatives---December retail sales, weekly jobless claims, November
business inventories/sales, the Philly Fed index and December PPI; neutral---the
latest Fed Beige Book, the December US budget, December industrial production
and December CPI.
As you can see,
these stats are pretty well balanced. I
think that the most important numbers were December retail sales and industrial
production---one in line, the other a disappointment. So I score the net result as slightly to the
negative. Perhaps more significant is
that every day so far in this earnings reporting season has witnessed a
negative earnings surprise from a major player.
Is this the first sign that the global economic malaise has finally
touched our shores? Too soon to
know. But whether or not it has, if we
continue to see companies reporting current results or forecasting future results
below estimates, it is almost surely a sign of some previously unanticipated
event or series of events.
Real retail
sales per capita (short):
There were few
economic stats from overseas; but that doesn’t mean that there wasn’t bad news’
(1) Russia---credit rating lowered and its 2015 growth estimates reduced (2)
Japan---2015 growth estimates lowered, (3)
China---its first real estate developer defaulted on an interest
payment, (4) Greece---a run on the banks, and most importantly (5)
Switzerland---removed its fixed exchange rate versus the euro.
On the other
hand, all was not bleak as central banks continue their flight to still easier
money: (1) the central bank of India lowered rates, (2) Abe promised even more
government spending and (3) [many believe] that the Swiss action was in
anticipation of a strong QE move by the ECB.
None of this has
yet impacted US macroeconomic data but there are enough negatives in the
foregoing to warrant turning on the warning light. Hence for the moment, our outlook remains the
same but with a bit less conviction 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.’
Update on big
four economic indicators (medium):
The pluses:
(1)
our improving energy picture. The US may be receiving benefits from lower
oil prices but negatives are starting to pop up that the ‘unmitigated positive’
crowd failed to consider. To be sure
nothing has showed in our macroeconomic numbers that would suggest a downside
to declining prices save the obvious with regard to oil and oil service companies. However, some of the positives like higher
consumer spending in other segments have not occurred as witnessed by the lousy
December retail sales and the declining level of consumer credit card debt.
The real risk
here is the magnitude of subprime debt from the oil industry on bank balance
sheets and the likelihood of a default.
I haven’t seen a good analysis of level of oil prices at which defaults
become manifest. But given the prior
history of the banksters, I have to at least reckon with the prospect that
lending in this area has been overdone and the banks, once again, have a load
of bad debt on their books.
Here is a stab
sat putting numbers on the subprime oil debt and who owns it (medium):
The Fed and oil
prices (medium):
Until we get
more substantive evidence on the impact of lower prices for the US, I am
leaving this factor as a positive.
However, I am not going to stop worrying about the negative case, in
particular, the extent of bank lending to the subprime sector of the oil
industry.
The
negatives:
(1) a
vulnerable global banking system. This
week the US headlines were all about earnings disappointments, specifically
those of JP Morgan, BofA and Citicorp.
To be clear, the shortfalls were largely a function of fines levied for past
sins---which admittedly says nothing about my real concerns: exposure to
derivatives and the level of high risk debt [see oil lending above] that exist
on their balance sheets. However, it
does mean that the banks have lower reserves that can be used to offset those
risks were they to occur.
Overseas, the
unexpected move by the Swiss National Bank raises concerns [a] about a loss of overall investor/public
confidence in central banks and [b] that this is a sign that the artificial
interference in monetary policy{like QE}
ultimately doesn’t work and will only result in more pain than would
have occurred without the artificial interference.
‘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. Congress managed to keep its head down this week, though their rhetoric
as well as that from the White House suggest that we are in for a colorful
albeit reform resistant next two years.
(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.
The QE forces
struck again this week:
[a] the central
bank of India lowered interest rates,
[b] as noted
above, all eyes are on the ECB which this week received a ruling from the ECJ
advocate general that QE was legal under EU law. The ECB also announced that it is ‘planning
to design’ a sovereign debt purchase program based on paid in capital
‘contributions’ made by big EU central banks.
I have noted previously that from the analysis that I have seen, I don’t
think that the ECB has the ability to do much.
Indeed, Draghi’s noticeable lack of action to date supports that notion. That
said, the ECB meets this coming Thursday when we will get Draghi’s sovereign
debt purchase plan {QE}.
And (short):
However, the
key monetary development this week was the Swiss National Bank removing Swiss
franc/euro fixed conversion rate. The
move was likely executed on the assumption that the ECB would implement a
meaningful of QE and that would in turn exacerbate the already painful flow of
money exiting the EU looking to the Swiss banking system as a safe haven. [see
above]
Here is a piece
from Barry Ritholtz, who I respect a lot, arguing that QE has been a
success. I disagree heartily. His main argument is that because the US had
QE and its economy is the best in the world that that means QE worked. My response is correlation does not mean
causation. In my opinion, the US is
better off because we have more entrepreneurs and harder workers than anyone
else. Indeed, as I have argued many
times, the US is better off in spite of QE.
So I include this for a different perspective.
(3)
geopolitical risks. The world was relatively quiet this week.
Despite this 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. As I noted above, there was
little economic data from the rest of the world this week though there were
plenty other signs of weakness: lower GDP growth forecasts for several
countries, lowered credit ratings and a bankruptcy.
Furthermore,
the continuing decline in oil prices keeps alive concerns that [a] their impact on the economies of the oil
producing nations will act as a governor on global growth and [b] sooner or
later, they will affect the internal workings of the oil consuming countries.
Finally,
this week the news on the potential Greek exit from the Eurozone came in the
form of a run on the Greek banks. This
situation has reached the chaos stage.
While I have no idea if it will result in a default on its sovereign
debt that then ripples through the EU banking system, the risk certainly has
not gone away. This author believes that
the odds of an exit are small (medium and a must read):
Counterpoint:
More on
the run on Greek banks (medium):
My point in all
this is that the aggregate risks incorporated in a faltering global economy I
believe is the biggest threat to our own economic health.
Bottom line: the US economic news was mixed this week. That is par for our course. However, I think
that the string of disappointing corporate earnings reports should be viewed as
a potential threat to our forecast---not enough yet to revise it but enough to
heighten concern. The good news is that there
is still nothing to suggest that any negative fallout from a slowing world
economy is at our door.
The QE advocates
received more good news this week from India, Japan and the ECB. Not that that has been shown to be a recipe
for improving growth; but who needs that fact when stocks prices are roaring. It is truly amazing to me that the central
bankers don’t grasp the fact that cheap money results in easily financed
overproduction which leads to lower prices (deflation from more supply than
demand) which leads them to make money even cheaper (to promote
inflation). And the wheels just keep on
turning.
Falling oil
prices, lower global growth expectations and the disruptive action by the Swiss
central bank were the principal headlines this week. All hold the potential for negative
consequences in particular the latter as it relates to a loss of faith in
central banks and the long term efficacy of artificial interference in monetary
policy (QE).
This week’s
data:
(1)
housing: weekly mortgage applications and purchase
applications soared,
(2)
consumer: weekly
retail sales were up; December retail sales were awful; weekly jobless claims
rose much more than anticipated; preliminary January consumer sentiment was up
big,
(3)
industry: November business and sales disappointed; the
January NY Fed manufacturing index was well ahead of consensus while the
Philadelphia Fed Index was terrible; December industrial production was in
line; the December small business optimism index was better than forecasts,
(4)
macroeconomic: the latest Fed Beige Book was jabber;
December PPI fell slightly more than estimates but ex food and energy it was
much stronger; CPI was basically in line; the December budget was in surplus
but less than consensus.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17511, S&P 2019) had another highly volatile week but still
closed within uptrends across all timeframes: short term (16394-19164, 1902-2283),
intermediate term (16443-21608, 1729-2443) and long term (5369-18860, 783-2083).
In fact the
volatility was so significant, it made making technical comments on the
Market’s pin action a fairly useless endeavor because everything could be reversed
in 24 hours---and often did: the Averages busted out of their pennant patterns
on Wednesday, traded below their previous higher lows on Thursday, then
recovered to the lower boundaries of the aforementioned pennant formations on
Friday.
So the question
is, was the break in the pennant formations a false flag or was the Friday pop
largely a function of option expiration and short covering in front of a long
weekend? I am not sure; but I do know
that the trend in lower highs (the upper boundary of the pennant pattern) is
intact, that we have three seasonal indicators all pointing lower (Santa Claus
rally, first two day of trading in January, first five days of trading in
January) and that the lower boundary of the pennant formations was initially a
support level that has become a resistance level. So I think that the evidence suggests more
downside. However, as I noted at the
beginning of this comment, volatility of late has made technical forecasting of
limited value.
Volume jumped on
Friday but that was at least partially a function of option expiration; breadth
improved dramatically. The VIX slumped, closing back below the upper boundary
of its short term trading range (thereby negating Thursday’s break), within an
intermediate term downtrend and above its 50 day moving average.
The long
Treasury moved up strongly again. It
finished above the upper boundaries of both its short term and intermediate
term uptrends and well over its 50 day moving average. Taking out those upper boundaries is a pretty
good sign that technically the TLT is getting overbought; so some consolidation
would not be surprising. However, it is
being driven by a number of upsetting fundamental factors that could keep all
trends intact.
GLD was also up on
Friday, closing above the upper boundaries of its short term trading range and
intermediate term downtrend. A finish
above the upper boundary of its short term trading range on Tuesday will re-set
that trend to up. A close above the
upper boundary of its intermediate term downtrend on Wednesday will re-set that
trend to a trading range. This certainly
looks like a bottom in the making; but we need to let our time and distance discipline
work its way out.
Bottom line: the
Market’s schizophrenia this week was enough to drive anyone to drink. At the moment, the most important thing is
that all trends in both of the Averages are up.
But we can’t ignore that the Market’s trading pattern of the last couple
of weeks could be signaling the formation of a top. Not saying it is---‘could be’ being the
operative words. Nothing is clear but it
has my attention with bonds soaring and GLD attempting to score a turnaround.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17511)
finished this week about 46.7% above Fair Value (11933) while the S&P (2019)
closed 36.1% overvalued (1483). 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.
As a result of
this week’s data/events, the overall investment picture became more
negative. The US economy continues its sluggishly
improvement. However, the first week of
this earnings season was quite discouraging. Every day, we were treated with a
disappointment of some sort from a major company. If this trend continues, then clearly overall
profits will be below estimates; and since valuation boils down to earnings
times a discount factor, a key component will point to lower equity
prices.
Overseas, there
was little by way of economic stats.
However, significant developments occurred, most of which have negative
implications for stocks: downgrades of GDP growth, downgrades of credit
ratings, the Swiss currency action, the run on Greek banks. To be sure, we received our usual dose of
increasing QE (India, Japan, probably Europe).
However, the Swiss bank’s steps in their currency is by far the most
important event this week and it may have triggered the investing public’s
possible loss of confidence in central banks and the extremes to which QE has
gone. So the question does occur as to
whether additional QE news (or any central bank move for that matter) will
carry the weight that it has for the past six years. I am not saying that this will happen; but I
am saying that we have to be aware that it could occur. (today’s must read)
In addition, the
global economies are still dealing with the fallout from declining oil
prices. More important, while we have
been listening to the ‘unmitigated positive’ crowd for six months, in the last
couple of weeks the negative side of this trade is starting to raise its
head---the most important elements of which are lower employment in the energy
space, declining capex and the magnitude of subprime debt on the balance sheets
of our banks. To be fair, so far none of
these negatives have showed up in the numbers---and may never. But if we gave weight to the positive side of
this development in our analysis, we have to do the same for the negative.
In short, the
initial trend in earnings reports raises my conviction that equities are
overpriced while my confidence in the sustainability of the US recovery is less
than this time last week---and for more reasons than just the disappointing US
earnings. Declining oil prices,
softening economic conditions throughout the world and the impact of the Swiss
National Bank’s action on the global carry trade as well as the potential loss
of investor confidence in global banking system are factors that could
conceivably knock our forecast off the tracks.
Whether or not
any of the prospective negatives materialize, it won’t change the fact that valuations
are stretched to extremes and the risk/reward equation at current prices levels
makes no sense.
Bottom line: the
assumptions in our Economic Model haven’t changed though the yellow light is
again flashing. In addition, the risk to
our global ‘muddle through’ scenario is greater than ever as a result of the continuing
decline in oil prices, disruptions in the global monetary system and a
potential Greek exit from the EU.
The assumptions
in our Valuation Model have not changed either. (I should point out than even if this fall in
profits gathers momentum, it wouldn’t alter our Model since the earnings
assumptions are based a smoothed secular growth trend which is below current
Wall Street estimates.) So I remain confident in the Fair Values calculated---meaning
that stocks are overvalued. As a result,
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.
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 1/31/15 11933 1483
Close this week 17511
2019
Over Valuation vs. 1/31 Close
5% overvalued 12529 1557
10%
overvalued 13126 1631
15%
overvalued 13722 1705
20%
overvalued 14319 1779
25%
overvalued 14916 1853
30%
overvalued 15512 1927
35%
overvalued 16109 2002
40%
overvalued 16706 2076
45%overvalued 17302 2150
50%overvalued 17899 2224
Under Valuation vs. 1/31 Close
5%
undervalued 11336 1408
10%undervalued 10739
1334
15%undervalued 10143 1260
* 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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