Saturday, April 11, 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 (revised)      0-+2%
                        Inflation (revised)                                                          1.0-2.0
                        Corporate Profits (revised)                                            -5-+5%

   Current Market Forecast
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Uptrend                                 16950-19727
Intermediate Term Uptrend                      17043-22179
Long Term Uptrend                                  5369-18973
                        2014    Year End Fair Value                             11800-12000                                          
                        2015    Year End Fair Value                                   12200-12400

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     1982-2963

                                    Intermediate Term Uptrend                       1789-2551
                                    Long Term Uptrend                                    797-2129
                        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 neutral for Your Money.   There was almost no economic data this week.  What we got was mixed: positives---weekly mortgage and purchase applications, month to date retail chain store sales, weekly jobless claims and the March Markit services PMI; negatives---the March ISM nonmanufacturing index, February consumer credit, March import and export prices and the wholesale inventories and sales combo; neutral---latest FOMC minutes.

The only primary indicator was the ISM nonmanufacturing index, which was slightly negative.  That should tilt the score to the negative side; but given the lack of meaningful stats, it is not worth counting.

We did receive a bucket load of meaningless blather from the Fed---designed to confuse and confound investors so they would take their eye off last week’s terrible nonfarm payrolls number.   I believe that this is all in the effort to keep the Markets sedated in hopes that they won’t realize that the Fed doesn’t have a f**king clue how to get out of the mess it has created.  Of course, it is not alone.  Every central bank out there is employing the same policy, I assume thinking that the Fed knows what it is doing. I guess they haven’t bothered to study the history of Fed forecasts and policy moves.

            One note: you may wonder why I listed declining import and export prices as a negative; after all, lower prices are good for you and me, right?  Yes, they are.  But if declining inflation motivates the Fed to stay looser longer, that is a negative.

            There was also a dearth of international economic data.  What we got was from Europe and for the fourth week it was generally upbeat.  It is still too soon to state with confidence that the EU is coming out of its slump; but clearly, I am getting closer.  One of the things that holds me back is the unresolved problems of Greece and Ukraine.  Either one could turn a nascent recovery on its head.

Speaking of the Greek bailout, the prime minister went to Russia this week looking for help.   He got nothing but some soft mewing from Putin.  But my guess is Putin is playing a waiting game.  If he offered a viable alternative that would likely prompt the EU to bite the bullet and help Greece.  On the other hand, doing nothing could keep the EU playing hard ball; and if that really puts the Greek’s in a corner, he would likely make a much better deal for Russia’s help. 

Our forecast:

 ‘a below average secular rate of recovery, exacerbated by a declining cyclical pattern of growth,  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 hesitant 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 supplies remain abundant and that is a significant geopolitical plus.  Furthermore, lower prices should be constructive when viewed as either a cost of production or cost of living.  However, none of pricing positives have yet shown up in the macroeconomic stats.  Indeed, as I have been pointing out, that data only gets worse the further oil prices fall.’ 

Having said that, oil prices have been in a trading range for some time now, suggesting that the ‘unmitigated positive’ of lower prices may be coming to an end.  Weighing against that is (1) the continuing build in inventories, (2) a possible Iran deal that would remove oil sanctions and (3) this week’s announcement by Saudi Arabia that it is jacking up production.

Why the Saudi’s are doing it (medium):

If the past is any guide, we should hope that oil prices have at least stabilized.  I don’t know if the US economy can handle more ‘unmitigated positives.

Of course, the problem that I am really worried about is the impact lower oil prices [employment, rig count, cash flow] have had on the subprime debt from the oil industry on bank balance sheets and the likelihood of a default. 

The financial sectors exposure to shale oil debt (medium and an absolute must read):

       The negatives:

(1)   a vulnerable global banking system.  This week: all quiet.

But that doesn’t mean our financial system is healthy (must read)

‘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. Gone fishing.   No news.

(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 Bank of Australia left key rates unchanged but stated that it was prepared to lower them more if necessary, (2) the Bank of Japan gave a two thumbs up to its own massive QE, even as the evidence mounts of its complete failure, (3) the Swiss government sold 10 years notes at a negative interest.  While clearly not a central bank action, it is illustrative of the consequences of the EU QE, (4) our own cracker jack Fed, had several members making more confusing comments on the next rate hike accompanied by pabulum in the minutes from the latest FOMC meeting and finally, (5) Jamie Dimon cried ‘bubble’.  You know that when one of the chief beneficiaries of QE starts condemning it, there is trouble in River City.  Or is he just establishing his defense for the next bank bailout?

(4)   geopolitical risks: tensions in the Middle East remain.  The Saudis appear to be making no progress wrestling control of Yemen from the Houthis rebels.  Meanwhile, naval action between the US and Iran has picked up around the mouth of the Red Sea. 

On another US versus Iran matter, arguing over the ‘recent format for an outline of a deal’ with Iran is in full swing.  Making matters worse, Iran’s stated interpretation of the several critical provisions of the agreement is dramatically different from Obama’s.  How these get resolved is to be determined.  My own bottom line is that Iran needs a deal more than the US, so there is no reason to give away the store for the sake of a ‘legacy’  especially when it could come back and bite You like such things as ‘ISIS is the JV’ and ‘Yemen is an example of our success’.

Iran gives us something else to think about (medium):

In Syria, ISIS has penetrated to within miles of the presidential palace in Damascus with multiple independent militias switching sides like a Roman orgy.  The good news is they are following my prescription---killing each other without an American in sight.  The bad news is that if ISIS actually deposes Assad, the US will likely get involved.

In addition, …I am…concerned about the lack of appreciation by our leadership of radical Islam’s intent to bring the war to our home.  My fear is that it will take a major catastrophe [like burning people alive and mass beheadings aren’t enough] to make Our Glorious Leader realize how irresponsible, unsound, dangerous and intellectually vacuous our current ‘local law enforcement’,’ jobs for jihadists’ strategy [?] is. 

The Ukraine/NATO/Russia standoff hasn’t generated many headlines of late; however a step up of arms purchases by Germany is worth noting:

(5)    economic difficulties, overly indebted sovereigns and overleveraged banks in Europe and around the globe.  That said, Europe continues to turn in upbeat economic results---this week coming from the UK, Germany and the consolidated EU data.  As I noted above, [a] it is still too soon to turn positive on the EU economy and [b] the problems of Greece and Ukraine remain unresolved and if not handled properly could have a very negative economic impact. 

With respect to the former, I don’t believe we can take comfort in any meaningful progress toward a bailout agreement in this week’s developments which included {i} the Greek PM going to Russia in search of aid and {ii} the Greek parliament voting to investigate a way of renouncing prior ECB loans.

‘Muddling through’ remains the assumption in our Economic Model.  Hopefully, the recent EU data will continue to improve; which should improve the odds of this scenario.  On the other hand, [a] a Grexit remains a decent probability and no one knows the unintended consequences of such an event and [b] the Chinese and Japanese economies continue to falter and they collectively are bigger than the combined EU economies. This remains the biggest risk to forecast.

The latest data out of China (short):

Bottom line:  there was too little US economic news this week to make judgment about trend.  Earnings week commenced as estimates continued to be lowered. 

Overseas, the EU economy is still showing improvement. Meanwhile, QE remains the principal theme among the central bankers.  My immediate concern is that these actions add fuel to the currency devaluation race---the history of trade wars generally suggest that they don’t end well. Further, I believe that the ultimate price for the largest expansion in global monetary supply in history will be paid by those assets whose prices have been grossly distorted, not the least of which are US equity prices.

The geopolitical hotspots remain unresolved (1) the Greeks and the Troika appeared to make no progress this week, as the Greeks continued to look for ways to weasel out of repaying their debts, (2) the Ukraine/NATO/Russia standoff continues and (3) the Middle East violence has escalated raising the odds of a Sunni/Shi’a civil war---which almost certainly won’t leave oil supplies unscathed.

This week’s data:

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

(2)                                  consumer:  weekly jobless claims rose but less than estimates; month to date retail chain store sales were up nicely; the headline February consumer credit number was better than expected but the internals were very disappointing,

(3)                                  industry: the Markit March services PMI was slightly better than estimates while the ISM nonmanufacturing index was a little worse; wholesale inventories grew more than anticipated, but sales declined,

(4)                                  macroeconomic: the minutes from the latest FOMC meeting; in March both import and export prices dropped.

The Market-Disciplined Investing

The indices (DJIA 18057, S&P 2102) had a good week.  They closed above the lower boundaries of their very short term uptrends (negating that trend) and their 100 day moving averages.  On a short term basis, they still need to overcome resistance offered by a very short term downtrend and the late February high before they even start to challenge the upper boundaries of their long term uptrends.  I continue to believe that those boundaries will prove extremely difficult to surpass in any meaningful way.

Longer term, the indices remained well within their uptrends across all timeframes: short term (16950-19727, 1980-2961), intermediate term (17026-22162, 1789-2551 and long term (5369-18873, 797-2129).  

Volume rose; breadth improved.  The VIX was down, finishing within its short term trading range, its intermediate term downtrend, its long term trading range, below its 100 day moving average and below the lower boundary of that developing pennant formation.  A close there Monday will negate the formation, suggesting more downside (upside for equities).  I continue to think that the VIX remains a reasonably priced hedge. 

And this on the VIX (short):

The long Treasury rebounded on Friday, ending a slightly down week.  It finished within its short term trading range, intermediate and long term uptrends and above its 100 day moving average.  TLT has been running in place for almost three weeks now---a break one way or the other could prompt some action in our Portfolios.

GLD’s price rose, closing back above the lower boundary of a very short term uptrend thereby keeping it in tact.  It remains within its short and intermediate term trading ranges, its long term downtrend and below its 100 day moving average.  GLD still has a number of tough resistance levels yet to overcome before we can assume that the worst is over.

Bottom line: short term, the Averages seem to have developed some momentum to the upside; though the going has been tough and there remains two resistance points overhead to be overcome even before they can challenge the upper boundaries of their long term uptrend.  If they get that far I believe those boundaries will prove impenetrable.

That said, longer term, the trends are solidly up and will be so until the short term uptrends, at the very least, are negated.
Fundamental-A Dividend Growth Investment Strategy

The DJIA (18057) finished this week about 50.0% above Fair Value (12036) while the S&P (2102) closed 40.6% overvalued (1495).  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.

Nothing in this week’s very sparse economic numbers or the world’s central banking community’s drive for QE global supremacy alters the assumptions in our Valuation Model.  On the other hand, the continuing improvement in Europe’s data does bring hope that any decline in the world wide economy might not be as bad as many Street models may have it and hence could change some assumptions in their valuation models. 

Unfortunately, the continuing enthusiastic global embrace of QE makes the problems that it has generated worse (misallocation of investment, asset mispricing, encouraging speculation, beggar thy neighbor currency devaluations, negligible economic improvement).  Regrettably, it will also likely make the correction process in the securities markets more painful when it occurs.

Geopolitical risks have not declined. The Greek bailout talks have progressed very little, the outcome of the current Ukraine/NATO/Russia standoff is uncertain and the military developments (Iranian naval movement in the Red Sea and Saudi failures in Yemen) in the Middle East are increasing the explosive potential there.

‘As I noted last week, I have no clue how to quantify the aforementioned geopolitical risks’ impact on our Models even if I could place decent odds of their outcome because: (1) the outcomes are mostly binary, i.e. Greece either exists the EU or doesn’t and (2) they all most likely incorporate potential unintended consequences, which by definition are unknowable.  Better to just say these are potential risks with conceivably significant costs and then wait to see if we ‘muddle through’ or have to deal with those costs.  The important investment takeaway, I believe, is to be sure that your portfolio had at least some protection in the downside.’

Bottom line: the assumptions in our Economic Model have recently changed.  While they will have no effect on our Valuation Model, if I am correct they will almost assuredly result in changes in Street models which will have to bring their consensus Fair Value down. 

The assumptions in our Valuation Model have not changed either; though there are scenarios listed above that could lower Fair Value.  That said, our Model’s current calculated Fair Values are so far below current valuation that any downward revisions by the Street will only bring their estimates more in line with our own.

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.

Who couldn’t love this market? (medium):
DJIA                                                   S&P

Current 2015 Year End Fair Value*              12300                                                  1525
Fair Value as of 4/30/15                                  12036                                                  1495
Close this week                                               18057                                                  2102   

Over Valuation vs. 4/30 Close
              5% overvalued                                12637                                                    1569
            10% overvalued                                13239                                                   1644 
            15% overvalued                                13841                                                    1719
            20% overvalued                                14443                                                    1794   
            25% overvalued                                  15045                                                  1868   
            30% overvalued                                  15647                                                  1943
            35% overvalued                                  16248                                                  2018
            40% overvalued                                  16850                                                  2093
            45%overvalued                                   17452                                                  2167
            50%overvalued                                   18054                                                  2242
            55% overvalued                                  18655                                                  2317

Under Valuation vs. 4/30 Close
            5% undervalued                             11434                                                      1420
10%undervalued                            10832                                                       1345    15%undervalued                            10230                                                  1270

* 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. 

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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