Saturday, February 7, 2015

The Closing Bell

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                                 16548-19324
Intermediate Term Uptrend                      16589-21744
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                                     1922-2903

                                    Intermediate Term Uptrend                       1750-2464
                                    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                        53%

The economy is a modest positive for Your Money.   The US economic data this week was weighted to the negative: positives---weekly mortgage applications, weekly jobless claims, January nonfarm payrolls, December consumer credit, January retail chain store sales and weekly retail sales; negatives---weekly purchase applications, December personal spending, the December PCE deflator, January light vehicle sales, January ADP private payrolls report, December construction spending and December factory orders, the December trade deficit and fourth quarter productivity and unit labor costs; neutral---December personal income, January Markit manufacturing index and the January ISM manufacturing index.  

The key numbers were (1) personal income and spending, construction spending and factory orders which were quite negative and (2) January nonfarm payrolls---a plus.  This is the second week in a row for poor showings among primary indicators.  While not yet a trend, it is enough to get my attention.  On the other hand, the disappointing earnings/guidance announcements continued to diminish.  Overall, I would much prefer to have lousy microeconomic indicators (earnings reports) coupled with encouraging macroeconomic numbers than the other way around.  Unfortunately, we got the latter this week.  And this keeps that yellow light flashing.

Goldman on the jobs report (short):
Oil prices joined stocks on the Texas Shock Wave.  Its ups and downs had investors bobbin’ and weavin’ all week.  The clear question is, was the rally part of the ups and downs a false flag or has oil made a bottom?  I don’t know the answer to that; but if it has made a bottom, then all those optimistic gurus declaring low prices an ‘unmitigated positive’ now have to figure out how to address higher oil prices.  That is in addition to explaining why stocks nosedive when oil prices fall.

Greece remained in the headlines, though by Friday the news flow was so confusing, no one has a clue how this situation will get resolved including the Greeks and masters of the universe in the ECB.  Which leaves the risk of a Greek default as a potential further depressant on EU economic growth.

The question in all of this is, is the current poor string of key US economic indicators an initial signal that global woes are starting to have an impact?  My answer is ‘not yet’ but I am at defcom 3.   Hence for the moment, our outlook remains the same but with a bit less conviction (flashing yellow light) 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.  Oil rocketed higher this week. Still through all its gyrations, we have little indication that it is impacting our economy save specific problems one would expect to occur in the oil and oil service industries.  Confusing the issue is fact that the gurus keep telling us lower oil prices are a plus for the economy, yet there is also no sign of that.  On the contrary, the one signal we do have is the Market keeps goes down when oil prices decline.

As you know, my main concern is magnitude of the subprime debt from the oil industry on bank balance sheets and the likelihood of a default.  Here too there is nothing substantial; just speculation about the potential danger.  That said until we can definitely say that lower oil prices are bad for the economy overall, I am leaving this factor as a positive. 

       The negatives:

(1)   a vulnerable global banking system.  This week [a] S&P lowered the credit rating of a number of EU banks; no doubt reflecting their overleveraged balance sheets, [b] oil prices rebounded which should reduce at least some of debt service problems about which I have been worried and [c] perhaps most important, the battle over Greek finances heated up a bit this week, though I have no clue how this situation resolves itself.  While much of Greek debt is now held by the central banks which clearly lessens the risk of contagion, we still don’t know what the ultimate impact of a Greek default on banking system.  I suspect that it is not zero.

Plus the latest stats show total global indebtedness higher than 2007 (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.  Obama killed a forest this week when He produced His seven thousand page budget which has absolutely no chance of being enacted.  The pols are just getting warmed for what will likely be a Mexican standoff in which the only casualties will be the US economy/taxpayers.

According to Keynes, the US should be running a budget surplus (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. 

Australia and China hopped on the easy money/beggar thy neighbor bandwagon this week; and Denmark quadrupled down with its fourth interest rate cut in a month.  This simply makes the outcome [potentially disruptive competitive devaluations] of an untried but massively executed monetary policy all the worse.  Except for QEI, this whole exercise has had zero effect.   Indeed, we are now getting another example of its ineffectiveness as interest rates in Japan are rising despite its triple all-in, balls to the wall, give me liberty or give me death approach to QEInfinity.  Given the magnitude of Japanese government debt, if this trend continues, Abe, the government and the Japanese electorate are totally f**ked because there is no way to service that debt except to print more money into obscurity.

From Paul Singer: the consequences of money manipulation are unknowable medium and a must read): new

`                                  China warns of QE crisis (short):

                                   NY Fed warns of negative interest rates (medium):

(4)   geopolitical risks.  The Ukrainian economy is holding on by its fingernails---it now looks like it can’t service its debt; plus it looks like the US now has boots on the ground there.  And as reported yesterday, Russia put its nuclear ICBM’s on combat patrol, coincidently on the same day of a Kerry visit to Ukraine.

The political situation in the Middle East is changing by the minute---Jordan is now being pulled into the vortex and the UAE and Turkey are threatening to go to the sidelines if the US doesn’t step up its actions against the Assad regime.  Meanwhile, Obama continues His peace initiative towards Iran---the policy rationale for which is totally lost on me.  I have no idea how these conflicts resolve themselves; but I do know that they both contain potentially explosive elements that could suddenly have negative global geopolitical implications.

(5)    economic difficulties, overly indebted sovereigns and overleveraged banks in Europe and around the globe. This week, the trend is horrible economic news turned a bit positive: negatives: S&P and Moody’s lowered Greece’s credit ratings; Chinese manufacturing and service PMI’s, lower forecast growth and inflation in Australia; positives: the EU manufacturing PMI and German: Italian and Spanish services PMI’s; German industrial orders; and the EU raising its growth forecast for 2015---the latter of which, in all fairness, is simply the latest example of their long term propensity for wishful thinking.  The question clearly is, are the upbeat stats a sign of improvement or just a pause in the storm.  I await more data.

Moreover, the economic difficulties of Greece appear no closer to being resolved.  Indeed, the situation is a bit more confusing after two days of happy talk between the new Greek PM and other EU officials was followed by a ‘no can do’ statement from the Germans and an ECB announcement hamstringing the Greek banks from getting additional funding [to stay solvent].  Again, the possible end game is this dilemma ranges from complete cooperation to a Greek exit from the EU, meaning that ultimately the risk of some political/economic mishap only adds to the risk that the global economy could slow further or slip into recession---which I believe makes this factor the biggest threat to our own economic health. 

Yesterday’s late in the day turd bomb from the ECB (short):

The global debt bubble in three easy charts (short):

Bottom line:  the US economic news this week was lousy and follows a not so hot set of numbers last week.  Still it is far too early to be changing our forecast. On the plus side, the trend in corporate earnings/guidance improved further this week. But is this potentially negative microeconomic signpost being replaced by a more significant deterioration in the macroeconomic numbers?  I don’t know; but the yellow light is flashing. 

Easy money received three more endorsements this week (Australia, Denmark and China).  Unfortunately, its bright and shining promise also got a dose of disappointment as the leading proponent (Japan) of QE began getting smacked with higher interest rates.  That, of course, is not supposed to happen because aside from being another stake in the heart of QE, it plays merry hell with the ability to service all that QE debt.  It may also be an indication that the more QE quest goes on, the more likely it is for disruptions in global trade and/or the financial system.

Devaluation is the next great risk from China (medium and a must read):

Along with the unwinding of the ‘carry trade’ (medium):

The negotiations between the Greeks and the EU/ECB went round and round this week but no one has a clue as to where they will go.  I do know that the outcome represents a potential threat to our ‘muddle through’ scenario.  On the other hand, we received some decent economic datapoints from Europe this week; although it is clearly too soon to get jiggy with it.  Hence, the biggest risk to our economic forecast remains a slowing in the global economy.

This week’s data:

(1)                                  housing: weekly mortgage rose but the more important purchase applications were down,

(2)                                  consumer:  December personal income rose, in line, personal spending fell more than expected and the PCE deflator was slightly higher than estimates; weekly retail sales were up, January retail chain store sales were up, January light vehicle sales were below the December number; December consumer credit rose less than forecast; January nonfarm payrolls were very good, though the unemployment rose [probably a result of a rise in the labor participation rate---which is good], the January ADP private payroll reported showed less job growth than anticipated; weekly jobless claims rose less than consensus,

(3)                                  industry: December construction spending rose less than expected; the January Markit PMI manufacturing index and the January ISM manufacturing index came in a touch below forecast, December factory orders were disappointing,

(4)                                  macroeconomic: fourth quarter productivity fell while unit labor costs rose; the US December trade deficit was much larger than anticipated.

The Market-Disciplined Investing

            The indices (DJIA 17824, S&P 2055) had another highly volatile week; this one to the upside.   Hence, they remained well within their uptrends across all timeframes: short term (16548-19324, 1922-2902), intermediate term (16571-21726, 1750-2464) and long term (5369-18860, 783-2083).  Both traded back above their 50 day moving averages and confirmed the negation of the downtrend off their mid-December highs (although the NASDAQ failed to break that downtrend line).  This latest pin action seems to have reflect the re-establishment of a balance of strength between buyers and sellers, making the trading ranges established in mid-December (17288-17998, 1970-2080) the key battle ground.

Volume was up on Friday---continuing the pattern of being up on down days and down on up days; breadth deteriorated. The VIX was up slightly, closing right on its 50 day moving average and within its short term trading range and intermediate term downtrend.  Not a lot of Market direction information in this chart. 

The latest from TraderFeed (short and a must read):

The long Treasury got whacked this week.  I noted previously that the recent moonshot was likely to be reversed; and that now appears to be occurring.  While TLT demolished the lower boundary of a very short term uptrend, [a] those boundaries are invariably demolished and [b] it remains within uptrends across all trading ranges and above its 50 day moving average.  Nevertheless, we still need to see signs of price stability as it approaches the lower boundary of its short term uptrend and its 50 day moving average or I am going to begin to get nervous about our ETF’s Portfolio bond position.

GLD was treated even worse, blowing through our initial Stop Loss level like a hot knife through butter.  While it remains within its short term uptrend and intermediate term trading range and above its 50 day moving average, our Portfolio’s still Sold a portion of their holding when the Stop Loss price was breached.

Bottom line: the pin action this week removed the Market’s technical tilt from down to neutral.  Nevertheless, the volatility of equites is nerve wracking.  If that wasn’t enough, the yo yoing in oil, bonds and gold prices add to the overall technical complexity.  So until there is some directional clarity and fewer divergences, I think that the sidelines are the safest bet.  Meanwhile, I am watching the boundaries of the trading ranges set in mid-December.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (17824) finished this week about 48.9% above Fair Value (11966) while the S&P (2055) closed 38.1% overvalued (1487).  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.

This week’s data/events improved ever so slightly the overall investment picture.  The reasons are:

(1)    the initial week and a half of lousy earnings/guidance reports among major companies in key industries has lost all of its momentum.  I am assuming that means that while the season’s profits may fall short of expectations, they won’t be a disaster.  Indeed with approximately 75% of the S&P reporting, earnings are off about 5% versus fourth quarter 2013.

(2)    a modestly better flow of economic data from Europe.  Granted [a] this is only one week’s worth of stats, [b] on a worst case scenario, the current faceoff between the EU and Greece could turn the entire EU economy on its head and [c] the numbers from the rest of the world remain as miserable as ever. To be clear, I am not getting jiggy with a couple of positive EU datapoints; but an upbeat report is an upbeat report and shouldn’t be dismissed out of hand. 

That said, there was no shortage of disappointing news this week---hence, the ‘ever so slightly’ verbiage above.  First, the overall US economic dataflow was decidedly negative as were the primary indicators.  And this follows a week in which the stats were also negative---though not to the same degree.  While two weeks in a row of poor data is not encouraging, we have seen this play before: the economy appears to be weakening only to subsequently snap back.  Hence, I think it too soon to tinker with the economic assumptions in our Models.

QE received yet another boost this week.  This time from Australia, China and Denmark (for the fourth time in a month).  The big player here is, of course, China and as the above suggested, if these guys ever get rolling down the devaluation/deflation highway that will be tough to stop.

Finally, the Middle East and Ukrainian conflicts aren’t getting any better.  Indeed, the Middle East is nothing more than a giant clusterf**k and US policy is only making it worse.  While a significant escalation in violence in either sphere is likely a low probability, were it to happen, the impact on global markets would probably be meaningful.

Bottom line: the assumptions in our Economic Model haven’t changed though the yellow light is flashing as a result of some disappointing stats and terrible earnings/guidance reports.  This week we received (1) more poor economic data---but this is a pattern that has occurred and then righted itself; so I am not overly worried at this time and (2) a trend in earnings/guidance closer to what was originally expected.  Still this season will likely overall end as a modest disappointment.  However, I am not changing our corporate profit projections in our Valuation Model until first quarter 2015 earnings are in.

  Our global ‘muddle through’ scenario which still represents the biggest risk to our outlook, also got a touch of good news this week with better economic data out of EU.  Of course, it is too soon to know if this was just noise or represents an upturn in the European slowdown.  That said, the rest of the world showed little improvement, we are still faced with the potential of a highly negative outcome in the Greek debt dilemma and the possibility of a hair raising event in Ukraine or the Middle East.

Finally, the global central banks appear hell bent on pursuing a ‘beggar thy neighbor’ policy to its logical conclusion which if history is any guide well be a disaster.

The assumptions in our Valuation Model have not changed either.  Remember, even if our corporate earnings forecast is lowered, it won’t impact our Model which uses a figure tied to productive capacity and normalized margins.  Indeed, the number currently plugged into the Model is higher than represented in our outlook.  The one number that has the best chance of being altered is that of inflation/deflation depending on how world trade is impacted by the hotly pursued ‘beggar thy neighbor’ policies.    

That said, I remain confident that the Fair Values calculated are so far below current valuation that it would take the second coming of Jesus for stocks to have even a remote chance of not reverting to Fair Value.  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.

Why current P/E’s are unsustainable (medium):

DJIA                                                   S&P

Current 2015 Year End Fair Value*              12300                                                  1525
Fair Value as of 2/28/15                                  11966                                                  1487
Close this week                                               17824                                                  2053

Over Valuation vs. 2/28 Close
              5% overvalued                                12564                                                    1561
            10% overvalued                                13162                                                   1635 
            15% overvalued                                13760                                                    1710
            20% overvalued                                14359                                                    1784   
            25% overvalued                                  14957                                                  1858   
            30% overvalued                                  15555                                                  1933
            35% overvalued                                  16154                                                  2007
            40% overvalued                                  16752                                                  2081
            45%overvalued                                   17350                                                  2156
            50%overvalued                                   17949                                                  2230

Under Valuation vs. 2/28 Close
            5% undervalued                             11367                                                      1412
10%undervalued                            10769                                                       1338   
15%undervalued                            10171                                                  1263

* 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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