Thursday, May 7, 2015

The Morning Call ---Is Yellen serious?

The Morning Call


The Market

The indices (DJIA 17841, S&P 2080) were down again yesterday.  The S&P remained above its 100 day moving average, though not by much and continues in a very short term downtrend.  The Dow closed right on its 100 day moving average and within a very short term downtrend.  Remember that the 100 day moving average has provided great support for the last year; so it would not be a surprise to see a bounce from current levels, especially with the Market getting oversold.

Longer term, the indices continue to trade well within their uptrends across all timeframes: short term (17110-19907, 2003-2984), intermediate term (17245-22360, 1812-2585 and long term (5369-18873, 797-2129).  

Volume was flat; breadth mixed.  The VIX was up another 6%, finishing back above its 100 day moving average but remaining within a short trading range.  The last two days’ pin action notwithstanding, it has been more docile than I would have expected.  That said, its portfolio insurance value is less impressive.

The long Treasury got pummeled.  It ended below its 100 day moving average, within a short term downtrend and below the lower boundary of its intermediate term uptrend for a fourth day, negating that trend.  At the open this morning, our ETF Portfolio will Sell one half of its muni bond positions.  I remained concern about the current weakness and what it may mean for the underlying fundamentals.  That said, I am still not sure of the cause.  What I feel more sure about is that bond prices will lead stock prices whatever the reason.

A new bond bear market? (short):

            Or is this just a correction? (short):

            Yesterday, I offered the thesis that rates are rising because the bond vigilantes have recognized the inadequacies of low rates and that they will push the Fed to raise rates.  Here is a counterpoint (medium):

GLD fell, closing below its 100 day moving average and continuing to build a head and shoulders formation.

Bottom line: the indices are now at or near their 100 day moving averages, which as I have noted several times, has been a powerful support for over a year.  As long as it holds, the very short term trend is within a trading range bound by the 100 day moving average on the downside and the upper boundary of a very short term downtrend (the trend of lower highs) on the upside.  One of these boundaries has to break near term simply because they are converging. 

My prejudice is to the downside but that’s been my story for 18 months and I have been wrong.  One fundamental supporting that position is the damage being done in the bond markets.  That said, longer term, the Averages are solidly within uptrends across all timeframes.

The rapid decline in bond prices continues to make me nervous, especially since I don’t have a firm conviction as to why.  That, of course, doesn’t mean that things aren’t amiss.

            The difference between risk and volatility (short):

            ***overnight, Euronext Derivatives Market is having problems (short):



            Yesterday’s US economic stats were mixed to negative: weekly mortgage applications fell but purchase applications rose; first quarter nonfarm productivity declined but was in line while unit labor costs increased more than expected; finally, the April ADP private payroll report showed a decline in employment versus expectations of an increase.  The numbers still point to a declining rate of growth.
            Elsewhere at home, in an interview, Yellen pronounced stock valuation ‘quite high’---which I thought a bit unusual given the Fed’s current objective of higher asset prices.  Could she possibly be responding to the whackage in the bond market and proving once again that the Fed follows the bond market rather than leading it?   On the other hand, given that the record of Fed forecasts on the economy to say nothing of the Market has been so abysmal, I can’t imagine why anyone would take this seriously. (short):

            Overseas, the UK services PMI came in ahead of forecasts and the EU composite PMI was higher though not as much as anticipated.  So the case for improvement in the EU economy received another boost.

            ***overnight the EU April retail PMI was better than March’s reading but still in negative territory.
            In addition, Greece made a E200 million payment to the IMF but has another E750 million due on May 12.  Unfortunately, the odds of a bail out agreement before that happens are shrinking.
            Sources within the troika say that an agreement is not possible by next Monday (medium):

            Plus, foreign banks are cutting credit lines to Greek banks (medium):

Bottom line:  the economic stats were downbeat in the US but a plus abroad.  However, I don’t think that investors are noticing given the sudden weakness in the global bond markets and the rapidly approaching endgame in the Greek/Troika bailout standoff. 

The risk associated with the former are easier to quantify simply because we have all lived through periods of interest rate reversals and know roughly how stocks act during those periods.  There is legitimate disagreement on the timing of equities turn to the downside; but there is little reason to believe that ultimately they won’t pay the price. 

On the other hand, I don’t think anyone has a clue as to how the Greek financial crisis resolves itself and the consequences of whatever that end result will be---which makes the potential for a major surprise significantly higher over the near term.    

I am not arguing that either the bond market has bottomed and is heading higher or that the Greek problems will ultimately lead to financial disruptions.  But they both have a higher probability of occurring than they did last week, last month or six months ago; and stock prices are a milli short hair away from their valuations in those timeframes.

 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.

            Greg Mankiw on the virtues of index funds (short):

       Company Highlight

Lorillard Inc. produces and markets Newport, Kent, True, Maverick and Old Gold cigarettes.  The company has grown profits per share from $1.58 in 2006 to $3.35 in 2014 and dividends per share from $.61 in 2008 to $2.46 in 2014  earning a 60%+ return on equity.  LO should continue to produce above average returns as result of:

(1) increasing market share,

(2) product innovation, including investment in tobacco alternatives

(3) improved pricing,

(4) a stock buyback program.


(1) governments around the world are imposing restrictions on tobacco use,

(2) a highly competitive industry,

(3) the industry is not allowed to advertise.

Lorillard is rated A by Value Line, has a 600% debt to equity ratio but is working hard to reduce this figure.  Its stock yields 3.8%

    Statistical Summary

                 Stock     Dividend         Payout      # Increases  
                 Yield      Growth Rate     Ratio       Since 2008

LO             3.8%         10%              67%                6
Ind Ave      4.3             8                  65                 NA 

                Debt/                        EPS Down       Net        Value Line
              Equity         ROE         Since 2006      Margin       Rating

LO           600%         NA              0                   19             A
Ind Ave     70             50              NA                 14            NA


            Note: LO stock made great progress off its January 2009 low, quickly surpassing the downtrend off its December 2007 high (straight red line) and the November 2008 trading high (green line).  Long term, the stock is in an uptrend.  The wiggly red line is the 100 day moving average.  The High Yield Portfolio owns a full position in LO.  The stock is on the High Yield Buy List; the lower boundary of its Sell Half Range is $95.


       Investing for Survival

            12 things I have learned from Morgan Housel: Part 3

3. “Three of the most important variables to consider are the valuations of stocks when you buy them, the length of time you can stay invested, and the fees you pay to brokers and money managers.”
“The single most important variable for how you’ll do as an investor is how long you can stay invested. I’m always astounded when I think about compound interest and the power that it has for investing.  Time is massively powerful.”  
Each of the points made here by Morgan Housel has a major champion. On the first point, Howard Marks points out:  “It shouldn’t take you too long to figure out that success in investing is not a function of what you buy. It’s a function of what you pay.” On the second point, Charlie Munger puts it simply: “Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.”  On the third point there is John Bogle: “You get what you don’t pay for.”
An excerpt of a Motley Fool post called I Prefer to Keep Things Simpleby Morgan Housel helps explain compounding:

“What [too often] happens … is that the magic of compounding returns is overwhelmed by the tyranny of compounding costs. It’s a mathematical fact.
You’ve probably heard the story about the guy who invented the game of chess.
It goes like this: An inventor brought his chess board to the emperor of China, who was so impressed he offered to grant the man one wish. The inventor had a simple wish: He requested one grain of rice for the first square on the board, two grains for the second square, four for the third, eight for the fourth, and so on. Sounding like a modest proposal, the emperor agreed. But filling the chess board’s last 10 squares would have required 35 quintillion grains of rice – enough to bury the entire planet. Unamused, the emperor had the inventor beheaded.
While I doubt the story is true, its message is important to understanding the power of compound interest: When things grow exponentially, gains look tiny at first, modest in the middle, and then — very suddenly — they shoot utterly off the charts.” 
    News on Stocks in Our Portfolios

o    Becton, Dickinson (NYSE:BDX): FQ2 EPS of $1.61 beats by $0.08.
o    Revenue of $2.05B (-1.0% Y/Y) in-line.
·         CF Industries (NYSE:CF): Q1 EPS of $4.79 beats by $0.18.
·         Revenue of $953.6M (-15.6% Y/Y) misses by $24.15M.


   This Week’s Data

            Weekly jobless claims were up 3,000 versus estimates of up 18,000.


            Thursday morning humor (short):



Hillary on immigration (short):

Baltimore teachers (short):

  International War Against Radical Islam

            If true, this can’t be good (medium):

                The complex and confusing politics of the Middle East (medium):

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