The Closing Bell
6/27/15
Statistical
Summary
Current Economic Forecast
2014
Real
Growth in Gross Domestic Product +2.6
Inflation
(revised) +0.1%
Corporate
Profits +3.7%
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 17465-20271
Intermediate Term Uptrend 17645-23787
Long Term Uptrend 5369-19175
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2056-3035
Intermediate
Term Uptrend 1851-2619
Long Term Uptrend 797-2138
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 53%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy provides no upward bias to equity valuations. The dataflow
the week of June 22 beat Street
expectations by more than any other set of weekly stats this year: above
estimates: May existing and new home sales, weekly mortgage and purchase
applications, May personal income and spending, month to date retail chain
store sales, June consumer sentiment, the June Richmond and Kansas City Fed
manufacturing indices and the final first quarter GDP number; below estimates:
the May Chicago national activity index and the June Markit flash manufacturing
and services PMI’s; in line with estimates: the June durable goods and ex
transportation combo.
The more
important indicators were almost all above Street forecast: above estimates: May new and existing home
sales, May personal income and spending and first quarter GDP; below estimates:
none; in line with estimates: the May durable goods and ex transportation
combo. This marks the fourth week in a
row in which the majority of numbers have been above consensus. That’s great in that this performance likely
takes a possible recession off the table.
However, it follows eighteen weeks of data that were consistently below expectations. True, the weather and the West coast
longshoremen’s strike had an impact. Nevertheless, in my judgment, the growth
rate of the economy has still shifted down a gear and is growing at a lesser
rate than the already anemic pace of the current recovery from the financial
crisis.
Our forecast:
a much 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 conflicting
profit incentives 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
production in this country continues to grow which is a significant
geopolitical plus. However, we have yet
to see the ‘unmitigated’ positive attributed to lower oil prices by the
pundits. Not surprisingly, with oil
prices recovering somewhat, this same crowd is trumpeting the pluses that
rising prices will have on capital spending.
If they keep trying, the law of averages says that they will eventually
be right. But who will listen?
The
negatives:
(1)
a vulnerable global banking system. On Thursday, it was announced that JP Morgan,
our ‘fortress bank’, was implicated in yet another scheme to defraud the
public---this time for pushing private banking clients to buy the bank’s own investment
products.
My concern here is that: [a] investors ultimately
lose confidence in our financial institutions 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 from either subprime
debt problems in the student loan or auto markets or turmoil in the EU financial
system resulting from a Greek default or exit from the EU.
(2) fiscal
policy. Something positive for a change
from our ruling class. The congress gave
Obama His right to negotiate the Asian trade deal. Overall, I think it a plus for the
economy. Like most legislation, there
are some short comings: [a] renewal of the Import/Export bank charter---which I
am not a fan of and [b] the oft heard complaint of the erosion of congressional
powers by the executive.
To be clear, I
think the latter one of the most significant constitutional problems that the
US faces. That said, congress has been submitting
to this process for the last 75 years under both party’s rule and the only time
we hear complaints, it is more for partisan political reasons than anything to
do with the constitutional issue of separation of powers. So I might be more sympathetic if the current
legislative complainants had been fighting the massive overreach by executive
orders lo these many years. But that is
not the case. So, while I wish that someone
had the cojones to do something to change the trend in this process; but that
is not likely to happen. In the meantime,
if I was going to object to the usurpation of congressional authority, I have a
complaint list a mile long at the bottom of which would be free trade
negotiating power.
On a less
constructive note, the Supreme Court upheld the constitutionality of
Obamacare. Setting aside the act’s social/political
value, the economic affect to date has been as many expected---detrimental to economic
growth, especially as it applies to small business, which, lest we forget, is
the main driver of employment. It is
also far more expensive than was originally forecast and, hence, has become another federal program that either
sucks taxes out of the people or adds to the deficit---thus falling under the aforementioned
categories of ‘too much government
spending, too much government debt to service, too much government regulation’.
(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.
An absolute
must read:
(4) geopolitical
risks: tensions continue in Ukraine and there is no letup in the fighting in
the Middle East. However, they are
taking a back seat to the Greek standoff.
I will note that the US/Russian rhetoric has reached a point that is a
little concerning---my worry being a misstep by the administration which has
proven time and again its lack of skill in foreign affairs.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The headline remains the test
of wills between the Troika and the Greeks over a bail out agreement. While the rhetoric took a less discordant
tone the last seven days, the parties appear no closer to a deal. And time is running short---at least on the
current calendar of payment deadlines.
Adding even
more drama, the ECB said Thursday that it has ended its liquidity injections
into the Greek banks. Then on Friday,
the Troika gave Greece another final [if you believe that] ‘take it or leave it’
offer [as of this writing, details are unclear but we do know that it is only a
five month agreement] to be met by Monday; which the Greeks then rejected as ‘blackmail’
and threatened to call for referendum. Clearly,
this a minute to minute situation and may have changed by the time you read
this. Given history, we should never underestimate
the eurocrats’ ability to snatch victory from the jaws of defeat even with one
foot off the cliff.
My bottom line
here hasn’t changed: I don’t know how this ends and I don’t know what it means
for the markets if it ends badly; but I do believe that there will be
unintended consequences; and since those are by definition unknowable, this
situation demands some caution.
Here is the
really, really, really optimistic case (short):
Getting off the
Greek dilemma for a moment, the international economic news over the last seven
days has not been all that positive. The
EU flash composite index came in well above forecasts. Regrettably, the comparable Chinese number
was as bad as the EU was good---which along with a major stock selloff prompted
the central bank to ease monetary policy dramatically. In addition, June German business confidence
fell for the second month in a row, South Korea downgraded its 2015 economic
growth outlook and Japan, despite its Godzilla QE, can’t get off dead center---May
inflation and household spending were basically flat. Overall, nothing to suggest that the global
economy will make any contribution to our own growth beyond what is providing
now.
‘Muddling
through’ remains the assumption for the global economy in our Economic Model
with the proviso that if a Greek default/exit occurs, all bets are off. This
remains the biggest risk to forecast.
Bottom line: the US economic news continues to indicate
improvement from its first quarter swoon.
That is positive in that it, hopefully, is taking the recession scenario
off the table. But, in my opinion, that
in no way suggests any acceleration in our growth prospects above the rates
that existed in the preceding couple of years.
The
international data did little to demonstrate any kind of pick up in global
economic growth. But we did get, as we
are accustomed to, another central bank pushing the QE button---in this case
China, which is trying to deal with both lagging economic growth and a speculative
stock market. Sound familiar? So ‘the head in the sand’ monetary strategy
remains the keystone of global central bank policy. No one seems willing to consider the clear overall
failure of QE or the consequences of the misallocation and pricing of assets.
Finally, the
Greek/Troika negotiations are on a treadmill and time is running out. A resolution may still occur, but there
remains a decent risk that it will not.
This week’s
data:
(1)
housing: May existing and new home sales were better
than consensus; weekly mortgage and purchase applications were up,
(2)
consumer: May personal income and spending were above
estimates, month to date retail chain store sales were up; weekly jobless
claims rose less than expected; June consumer sentiment was higher than
anticipated,
(3)
industry: the May Chicago national activity index was
below forecasts; May durable goods orders were disappointing, but ex
transportation they were fine; both the June Markit flash manufacturing and
services PMI’s were below consensus; the June Richmond Fed manufacturing index
was much better than estimated while the Kansas City index, while negative, was
somewhat improved,
(4)
macroeconomic: the final first quarter GDP growth
number was -0.2%, in line but below the initial reading of -0.7%.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17947, S&P 2101) drifted lower on the week, trading down near the
lower level of their very short term trading ranges. The upper boundary of that range is marked by
the Averages prior highs (18298, 2135); the lower boundaries are their
respective 100 day moving averages. On
Friday, the Dow closed below its moving average for the third day in a row; the
S&P remains above its comparable level (2095) but just barely. I have previously noted that the 100 moving
averages have offered tremendous support over the past two years. So the question now is the reverse of one
that I posed two weeks ago when the indices appeared poised to challenge their prior
highs and upper boundaries of their long term uptrends: do the bears now have
the juice to push the Averages below those strong support levels? Follow through.
That said longer
term, the indices remained well within their uptrends across all timeframes:
short term (17465-20271, 2056-3035), intermediate term (17645-23787, 1851-2619)
and long term (5369-19175, 797-2138).
Volume rose
markedly on Friday; but that was primarily due to the Russell rebalancing. Breadth improved, more so than I would have
thought. The VIX was off fractionally, finishing
below its 100 day moving average and the upper boundary of a very short term
downtrend. Any price below 13, I believe
offers great value as portfolio insurance.
The long
Treasury got whacked again on Friday, closing below its 100 day moving average
and below the upper boundaries of its very short term and short term downtrends. Indeed, it ended right on the lower boundary of
its short term downtrend. So a technical
bounce here wouldn’t be a surprise; but the trend is still down and has decent
momentum. I continue to have a problem coming
up with an economic scenario that explains the 15% losses in the bond market
but vacillation near all-time highs in the stock market.
GLD continues to
do nothing. Oil remains at the upper end
of a short term trading range while the dollar closed below its 100 day moving
average and the lower boundary of a very short term downtrend.
Bottom line: the
indices are trendless at the moment, caught between their all-time highs and their
100 day moving averages. Resolution of
the Greek bailout dilemma likely holds the key to any directional move out of
that range and could swamp any short term technical factors.
Two other things
to watch that may also play a role in determining stock price direction are the
bond market and the Chinese stock market, neither of which present any optimism
for assuming higher stock prices.
My technical
bias remains to the downside primarily because I believe that the upside is
limited by the resistance I expect to be offered by the upper boundaries of the
indices long term uptrends while there is a much larger downside represented by
the lower boundaries of their short term uptrends.
That spread is clearly
not enough to warrant getting beared up.
However, the spread between the upper and lower boundaries of their long
term uptrends is something else again. That
should give pause to anyone dying to buy stocks at these price levels.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17947)
finished this week about 48.2% above Fair Value (12105) while the S&P (2101)
closed 39.8% overvalued (1502). 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.
The June 22 week
of US stats dovetails nicely with our forecast of no recession but decelerating
growth. Hence, there is no need to
challenge the longer term growth of productive capacity assumption in our
Valuation Model.
Likewise, as I have
noted previously, the Fed has already done its part to assure ‘a botched…transition
from easy to tight money’. It is now
facing the probability that unless it gets very lucky, (1) if it tightens, it will
run the risk of hampering or even stopping what sluggish growth the US economy
currently has or (2) if it doesn’t tighten, it still may have to implement QEIV
due to the aforementioned economic lethargy and/or events in Greece that produce
a shock that would necessitate a further infusion of liquidity to maintain
stability within our financial institutions---and that is just what we need: more
pricing distortion in the securities market and more asset misallocation.
Making matters worse, the long end of the
yield curve has been rising. That would
be normal in an environment of improving economic activity. Unfortunately the reverse is occurring; or
more correctly said, the economy is showing signs of stabilization after a
rough first quarter but is not likely to get back to its growth rate of a year
ago. My conclusion is that the bond guys
have lost faith in the Fed; and if that spills over into the equity market,
well, times could get tough.
We are getting
down to the short strokes in the Greek bailout negotiations. No apparent progress has been made in the
last seven days; and even worse, the ECB is ending its liquidity injections in
the Greek banking system---meaning a possible bank holiday on Monday if no
solution is achieved. Of course, there
were rumors of such an occurrence last weekend and nothing happened. I have no idea how this crisis gets resolved;
though if history is any guide it somehow will end positively, even if it doesn’t
correct failed fiscal policies of the past.
Further, I remain unclear as to the ultimate consequences of a default
or Grexit; but I suspect that they will impact the Markets negatively.
Bottom line: the
assumptions in our Economic Model are unchanged. If they are anywhere near correct, they will
almost assuredly result in changes in Street models that will have to take their
consensus Fair Value down.
The assumptions
in our Valuation Model have not changed either; though there are scenarios (Grexit)
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.
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; but
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.
Corporate dividends plus
buybacks now equal more than operating cash flow (short):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 6/30/15 12105
1502
Close this week 17947
2101
Over Valuation vs. 6/30 Close
5% overvalued 12710 1577
10%
overvalued 13315 1652
15%
overvalued 13920 1727
20%
overvalued 14526 1802
25%
overvalued 15131 1877
30%
overvalued 15736 1952
35%
overvalued 16341 2027
40%
overvalued 16947 2102
45%overvalued 17552 2177
50%overvalued 18157 2253
55%
overvalued 18762 2328
Under Valuation vs. 6/30 Close
5%
undervalued 11499
1426
10%undervalued 10894 1351
15%undervalued 10289 1276
* 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 47 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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