Friday, May 15, 2015

The Morning Call--A slowing economy remains good news

The Morning Call


The Market

The indices (DJIA 18252, S&P 2121) smoked yesterday, largely on a disappointing PPI number (low inflation = no rate hike).  Both remained above its 100 day moving average and were back above the trend of lower highs.  In addition, the S&P closed slightly above its all-time high, though the Dow fell short of its comparable level.

Longer term, the indices continue to trade well within their uptrends across all timeframes: short term (17168-19965, 2014-2995), intermediate term (17315-22432, 1820-2591) and long term (5369-18873, 797-2135).  

Volume was up slightly; breadth was a positive.  The VIX declined 7%, closing below its 100 day moving average, below the upper boundary of a very short term downtrend and within a short trading range---all a plus for stocks. 

With the S&P having closed above its prior high, I ran an update on our internal model after the close last night.  In a Universe of 140 stocks, 11 finished higher than their prior highs, 17 were at or near their all-time highs and 117 remained below.  Now if I were you and I saw these numbers, I would have two questions (1) is his model’s filtering system completely broken, that is, is it just spitting out garbage companies that don’t deserve to be making new highs?  You know what our Portfolios look like; so I will leave that judgment to you, (2) did the study split hairs, to wit, if a stock was within a point or so of its all-time high, was in counted as a negative?  The answer is that the stock had to be 5% off its high to qualify as a negative.   Clearly, this worm’s eye view of the Market in no way supports current Index price levels.

So much for sentiment indicators (short):

The long Treasury was up only slightly, despite the PPI report and its rousing reception by the equity market.  It finished near the bottom of its short term downtrend and below its 100 day moving average.

GLD had another good day, confusing since lower inflation usually leads to lower gold prices.  It ended above its 100 day moving average and right on the neckline of its head and shoulders formation.  If that line is challenged successfully, a short term uptrend would be set.

Ray Dalio on gold (2 minute video):

On the other hand, oil was off slightly; something you would expect if the economy is weakening.  However, it was also influenced by the Saudi’s taking a self-proclaimed victory lap on having put the high cost shale drillers out of business. 

The dollar finished below the lower boundary of its short term uptrend for the second day---negating that trend and resetting to a short term trading range. 

Bottom line: the very short term technical picture is potentially clarifying as both Averages closed above the trend line of lower highs.  If they remain there or higher, that trend line would be negated.  They still need to get above their prior highs before a very short uptrend can be proclaimed.  That isn’t a big deal for the S&P since it has already done it; however, the Dow still has some work to do. 

The discordant performance of bonds and gold remain an issue---at least with respect to the longevity of any uptrend that may develop IF they continue to reflect the potential for higher inflation, higher interest rates or stronger economy. I am still a bit confused by these mixed messages, though as I noted yesterday the growing lack of market liquidity is in that mix somewhere.  On the other hand, I wouldn’t rule out the possibility that some of the recent volatility was simply a reflex from the prior over extension of price. 

All that said, I still believe that (1) the risk reward in stock market at this point is in the favor of risk and (2) if the Averages will be capped on the upside by the upper boundaries of their long term uptrends which I believe represent formidable resistance.

            More on the seasonal performance of stocks (short):


            Yesterday’s US economic news was mixed: the weekly jobless claims number was better than anticipated, but April PPI suggested deflation---and that comes on the heels of Wednesday’s report that April export and import prices had declined.  Given that employment is a lagging indicator, the PPI and export/import prices provide more information on what is going on now.  Both offer additional evidence that our forecast for a slowing rate of economic growth is right on.

            No datapoints on the global economy.  There was a speech by the Greek finance minister suggesting that the maturity of the debt of his country held by other sovereigns, agencies and financial institution should extended far into the future (key canned laughter)
            The latest, laughable but not funny (medium):

Bottom line: our forecast for slowed economic growth was reinforced this week by some pretty pronounced deflation stats.  While it sent a thrill up the equity boys’ legs, the fixed income and gold markets were not nearly as excited.  If it were a one day phenomenon, I wouldn’t give it much of a second thought.  But the divergence and volatility that have gripped all the markets in the last couple of weeks is confusing, at least to me.  Unfortunately, the resolution to this confusion will involve clarity on economic and corporate profit growth and the level of interest rates (discount factor) both of which have an impact on stock prices.

I am not predicting a recession (though growth is demonstratively slowing) or a continuing rise in interest rates (though rates are dramatically off their lows percentage wise) and I certainly can’t quantify the magnitude of impact that declining liquidity will ultimately have on the markets---though I am increasing convinced that the latter will at some point will be an issue.   But as I noted yesterday, the volatility in all markets is suggesting that investors are starting to rethink the economic/valuation models. 

 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.

In the interest of being fair and balanced, I try to include opinions that differ from mine.  The article below argues that higher rates are good for stocks.  But his key assumption is that higher rates stem from a better economy.  So what if the economy continues to deteriorate (the E part of P/E) but interest rates rise because everyone finally realizes that QE is a shell game (the discount factor of P/E)?

                Here is an expansion on the economic growth part of the thesis that I outlined above (medium):

            Investment strategy thoughts from Keith McCullough---one of my favorites (medium):

       Subscriber Alert

            During our regular fundamental updated analysis of ConocoPhillips, it failed to meet the minimum financial hurdles necessary for inclusion in our Dividend Growth and High Yield Portfolios.  Hence, COP is being Removed from both Universes and will be Sold from each Portfolio at the market open.

      Thoughts on Investing

A Dozen Things I’ve Learned from Michael Price about Investing

1. “Of course, the macro questions are the hardest ones to figure out.  I am not trained to be an economist, and I don’t think economists get it anyway.   I am left with the bottoms-up, 10Q by 10Q analysis, and hope I have enough sense of where we are in the cycle…”  Michael Price is another successful investor who ignores macro forecasts in favor of a bottoms-up analysis.

2. “Never, never pay attention to what the market is doing. … Stay away from the crowd.” Mr. Market is not always wise. He sometimes will sell you a stock at a bargain or pay you more than it is worth.  The art of knowing the difference is value investing. Falling in with the crowd will put you under the sway of Mr. Market because Mr. Market is the crowd.

3. “The key question in investing is, what is it worth, and what am I paying for it?  Intrinsic value is what a businessman would pay for total control of the business with full due diligence and a big bank line. The biggest indicator to me is where the fully controlled position trades, not where the market trades it or where the stock trades relative to comparables.”  By thinking like a business owner Michael Price becomes a better investor. Buying share of stock in a business is owning a partial stake in a business.  If a share of stock is not a partial stake in a business, what exactly is it?  Anyone who thinks a share of stock is a piece of paper that people trade back and forth is in deep trouble as an investor. 

4. “We like to buy a security only if we think it is selling for at least 25% less than its market value.” It is refreshing to hear an investor assign a number of a “margin of safety”.  My assumption is that this 25% figure is a rule of thumb.  Many value investors would say that the margin of safety they are looking for is relative based on the risk of the particular business (e.g., the risk of a bakery business is not the same as the risk of a biotechnology company).

5. “If you really [want] to find value, you [must] do original work, digging through stuff no one else [wants] to look at. …The really important thing is to eliminate the Wall Street consensus, the Wall Street research. You need to understand where the company is in the world and what the competition is for the products, whether the products are any good, and whether or not the company has any pricing power or barriers to entry. … Think about the business, think about what you see without any input from Wall Street, do [your own] primary research.”   To generate alpha in investing you must occasionally be contrarian and be right about that contrarian view. In short, you must find a mispriced bet. To find a mispriced bet you are best positioned if you are looking where fewer people are looking.

6. “You can get lost in the spreadsheets.  You can’t rely on the projections that you put in the spreadsheets alone…  Depending too much on the Excel spreadsheet and forecast of discounted cash flows is a big mistake.”  Extrapolating the past into the future is a parlor trick favored by consultants and analysts. This process may seem logical to many people but it is pregnant with danger.  Complex adaptive systems produce changes that can’t be extrapolated. Things that can’t go on forever, don’t.

7. “The worst mistake investors make is taking their profits too soon, and their losses too long.”  This is classic “loss aversion” at work. People hate taking a loss even if it is sunk. Unless you are a trained investor your emotions can get the best of you.

8. “A good time to start in [the investing] business is when markets are terrible…. We wait for bad news… I love to read about losses.” A value investor likes prices to fall, especially when they have dry powder and can take advantage of the drop. A classic value investor looks at a price drop of a stock they like as a chance to buy more, whereas the ordinary investor may panic and sell.

9. “I couldn’t care less about getting zero on my cash. That’s ammunition.” Cash has optionality. Yes, that optionality has a cost which includes inflation.  Especially when inflation is low and prices of stocks are high, the price of the optionality can be well worth paying.

10. “For rates of return, smaller is better.  Returning excess returns at $20-$30 billion is not so easy.”  The more money an investor must put to work, the harder it is to generate investing alpha. Many opportunities are small in size relative to a big fund.  People only get so many investable ideas during the course of a year and some of them are not very big.  Another risk is psychological since sometimes an investor will compromise their principles on a big investment just to be able to put money to work.

11. “We know it’s easy to get swept away in a growth market. But I’ve been in this business more than 25 years and I’ve watched investors figure out a way to justify incredible multiples, only to see valuations collapse back to the underlying worth of the company. The key in the business is weathering the bear markets, not outperforming the bull markets.”  Value investing shines brightest when stocks are falling in price since they were purchased based on value.  Value investing principles can also help you avoid the flip side of bubbles (panics).

12. “A lot of people have the brains.  It is the judgment with the brains that matters, and that comes with experience and from thinking about things in the right way.” Intelligence without judgment and the right temperament won’t make someone a good investor. Intelligence can actually be a problem since the smarter you think you are, the more you may get into trouble trying to predict things that are not predictable.

      News on Stocks in Our Portfolios

   This Week’s Data

            The NY Fed’s May manufacturing index came in at 3.09 versus expectations of 5.0.




Obama’s fast track Trans Pacific partnership bill regains momentum in the senate (medium):

Germany not happy with the ECB, Draghi or QE (medium):

Quote of the day (short):

  International War Against Radical Islam

            More on the Iran nuke deal (medium):

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