Saturday, August 8, 2015

The Closing Bell

The Closing Bell


Visit our new investment website   www.investingfor

Statistical Summary

   Current Economic Forecast

                        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 Trading Range                       17385-18295
Intermediate Term Trading Range           15842-18295
Long Term Uptrend                                  5369-19241
                        2014    Year End Fair Value                             11800-12000                                          
                        2015    Year End Fair Value                                   12200-12400

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     2087-3026
                                    Intermediate Term Uptrend                        1882-2646
                                    Long Term Uptrend                                    797-2145
                        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%

The economy provides no upward bias to equity valuations.   The dataflow this week was very upbeat: above estimates: weekly mortgage and purchase applications, month to date retail chain store sales, June personal income, July consumer credit, weekly jobless claims, July nonfarm payrolls, July light vehicle sales, July ISM nonmanufacturing index, July factory orders and the July Markit services index; below estimates: July ISM manufacturing index, June construction spending, June retail chain store sales and the June trade deficit; in line with estimates: June personal spending and the July Markit PMI.

The primary indicators included June personal income (+) and personal spending (0), July ISM manufacturing (-) and nonmanufacturing (+) indices, July factory orders (+), June construction spending (-), June retail chain store sales (-), July nonfarm payrolls (+).  So in total the stats were quite positive while the more important indicators were slightly upbeat.  (This, by the way, follows a week in which the numbers were disappointing.)  In short, the data pretty much reflects 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 never saw the ‘unmitigated’ positive forecast by the pundits when oil prices initially cratered.  This week saw a continuation of a second leg lower---and still no ‘unmitigated’ positive.

       The negatives:

(1)   a vulnerable global banking system.  This week witnessed the beginning of a DOJ probe of Deutsche Bank into money laundering on behalf of Russian clients.  So there has been no letup in the banksters’ criminal behavior.

That said, as I noted two weeks ago, our ruling class is at least putting a governor on financial institutions ability to wreak economic havoc by imposing the capital surcharges for the too big to fail banks and commencing enforcing compliance with the ‘Volcker rule’ [banning taxpayer insured banks from making bets with their own money {i.e. prop trading desks}].  These measures have clearly helped mitigate the ability of the banksters to endanger the financial system.

(2)   fiscal/regulatory policy. Once again, Obama snubbed the constitution by passing legislation via executive fiat---this time His new ‘climate change’ initiative.  The social policy aspect aside, this will [a] cost industry an arm and a leg which will be passed on to you and me and [b] lead to the layoff of thousands of coal miners, with all the attendant ‘safety net’ expenses to say nothing of the human costs.  Of course this will likely be challenged in the courts; but so was Obamacare and look how that turned out. 

There was another development in Puerto Rico, to wit, a default of a bond issue.  To date, this hasn’t had much if any impact on the muni market in general and on our muni ETF’s in particular.

(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.  

The debate continues over whether the Fed will raise rates in September.  This week, the Atlanta Fed chief, who is a moderate, weighed in on the side of a hike---which seemed to steer the narrative in that direction; and the bond market models are now said to be pricing in a 52% chance of an increase. 

As you know, I am not convinced that it will make any difference one way or the other economically; because QE didn’t make much difference on the upside.  However, there is a school of thought that says that a rate hike will hasten a recession.  I can’t imagine one 25 basis point rate hike making that kind of difference.  If this economy is heading for a dip [which in my opinion has a much stronger likelihood than a pickup in growth], it will happen with or without a rate hike,  

Which gets back to part of my central point thesis with respect to the Fed--- it will botch the transition for easy to normal monetary policy; and in fact, this time around, it has already done it. 

The Fed, in my opinion, is too late in the timing of its transition to tighter monetary policy.  Unfortunately, all those QE inspired reserves still sit on the bank balance sheet and all that debt still sits on the Fed’s balance sheet.  And a 25 basis point rise in the Fed Funds rate won’t make a tinker’s damn to the economy. 

From Fed whisperer Hilsenrath (short):

Another part of my thesis is that while a return to normal monetary policy won’t impact the economy, it will have a dramatic influence on the Markets since that is where QE has had the most affect.  What bothers me at this point is that a Fed rate increase has been beat to death in the media for the last couple of months, so surely it is well discounted in the Markets.

Nevertheless, I believe that somewhere out there is an event that will trigger investor recognition of the futility of the QEInfinity and the harm that it has done to the US economy via the mispricing and misallocation of assets.  I would have thought that the latest data out of Japan, i.e. the weakest growth in real wages in six years, would register somewhere in investors’ minds that even super-duper QEInfinity not only hasn’t worked but has caused pain and suffering.  But that too has been ignored.

You know my bottom line: sooner or later, the price will be paid for asset mispricing and misallocation.  The longer it takes and the greater the magnitude of QE, the more the pain.

A must read from Doug Kass (medium):

(4)   geopolitical risks: little occurred of consequence this week other than the now raging debate over whether the Iran deal is good or bad.  Again, leaving aside the long term political and foreign policy issues, an approval of the treaty would have several short term positive economic impacts: [a] oil prices are likely to decline further as a result of Iran being able to export its production, and [b] relief from current trade sanctions are likely to lift Iranian economic activity which will benefit global growth. 

(5)   economic difficulties, overly indebted sovereigns and overleveraged banks in Europe and around the globe.  This week:

[a] the Greek’s are having a difficult time getting/staying in compliance with the wishes of the Troika.  Though so far they have been able to do so.  From all that I have seen and read, it makes no long term economic sense for the Greeks to grovel before the eurocrats.  But that is their decision; and as long as there are no stumbles, this situation will likely remain on the back burner.

 [b] the Chinese government continued attempting to muscle the Markets with mixed results.  After its initial efforts/successes, I thought that they had indeed buffaloed investors/sellers.  But that now appears to have been a bit premature.  Chinese Markets continue volatile despite ever more onerous policies impositions {banning trading by a US hedge fund and more restrictions on short sellers}; and the Chinese economy continues to generate data {government filters notwithstanding} suggesting that all is not well---which if true will only add to the growth problem the globe already has. 

On Friday, an outside economist estimated that the Chinese government has       injected $1.3 trillion into the economy via bailouts and stimulus.

In other economic news, the July EU Markit PMI was above expectations, while retail sales were dismal.  German industrial orders were up but actual production fell. Construction spending in the UK declined.

In sum, I am holding to our global economic ‘muddling through’ assumption; though China is something of a wild card.

Bottom line:  the US economy dataflow continues to improve from the stats generated in the first five and half months of the year; though the anecdotal numbers are not that encouraging.  At the moment, I think that (1) our forecast of a very slowly growing economy is right on, (2) nothing that is going to improve that performance and much that could derail it and (3) indeed, the anecdotal evidence is making me nervous that even our reduced forecast may be too optimistic.

The international data did little to demonstrate any kind of pick up in global economic growth.  Indeed, the numbers out of Japan and the EU paint a picture of economic frailty, while uncertainty related to the Chinese Markets’ volatility and current strength of the economy is concerning.  The biggest risk to our economy is growth problems in the rest of the world. 

This week’s data:

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

(2)                                  consumer: month to date retail chain store sales growth rose from the prior week, while the numbers for the month of June were disappointing; June personal income was higher than anticipated while spending was in line; July consumer credit jumped markedly; July light vehicle sales were above expectations; the July ADP private payroll report was not good; July nonfarm payrolls rose slightly more than estimates; weekly jobless claims were up less than consensus,

(3)                                  industry: the July ISM manufacturing index was below forecast, while the nonmanufacturing index was well ahead; the July Markit PMI was in line while the services PMI was above of expectations; June construction spending was well below estimates; July factory orders were slightly better than forecast,

(4)                                  macroeconomic: the June US trade deficit was slightly higher than anticipated.

The Market-Disciplined Investing

The indices (DJIA 17373, S&P 2077) had another rough day on Friday.  The Dow ended [a] below its 100 and 200 day moving averages, both of which represent resistance, [b] below the lower boundary of its recently re-set short term trading range {17385-18295}; if it remains there through the close on Tuesday, the short term trend will re-set to down, [c] in an intermediate term trading range {15842-18295} and [d] in a long term uptrend {5369-19175}.

For the second day, the S&P finished below [a] its 100 day moving average; if it remains there through the close on Monday, it will revert from support to resistance and [b] the lower boundary of its short term uptrend; if it remains there through the close on Monday, it will re-set to a short term trading range.  For the moment, it remains in uptrends across all timeframes (2097-3076, 1882-2648, 797-2145). 

What do stocks do after seven down days in a row (short)?

Volume fell; breadth was negative.  The VIX was down---a bit unusual for a down Market day---closing below its 100 day moving average and remaining within a short term trading range, an intermediate term downtrend and a long term trading range.
The long Treasury was strong for a second day, ending above [a] its 100 day moving average; if it remains there through the close on Monday, it will revert from resistance to support, [b] the upper boundary of its short term downtrend; if it remains there through the close on Monday, it will re-set to a short term trading range and [c] the lower boundary of a very short term uptrend.

GLD was up fractionally, but remained below its 100 day moving average and in downtrends across all timeframes.

Oil fell 3%, finishing below its 100 day moving average and within short and intermediate term downtrends. The dollar also declined, remaining above its 100 day moving average and within short and intermediate term trading ranges. 

Bottom line: participants in both the stock and bond markets are battling it out at key technical junctions.  In the stock market, pressure has been to the downside for the last week with considerable technical damage having been done to the Dow.  The S&P, which is much more reflective of stocks in general, is doing better than the DJIA; but it too has broken some key support levels.  Until these two Averages are back in sync, I am hesitant to suggest a change in trend.  However, clearly some serious work needs to be done by the bulls to avoid a technical breakdown.

The bond boys are in a food fight over whether the Fed is going to hike rates and/or whether the economy is slowing.  Trading over the last two days suggest that the no hike/economic weakness crowd in winning the argument.  That said, a couple of days’ worth of trading is hardly a trend.  But given that multiple trends could potentially be changing direction is cause to pay more attention.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (17373) finished this week about 42.7% above Fair Value (12169) while the S&P (2077) closed 37.6% overvalued (1509).  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 US economic data continues to support our forecast and hence the economic assumptions in our Valuation Model.  However, as I have been documenting over the last couple of weeks there has been a disturbing increase in the number of negative anecdotal economic stats.  Ordinarily, these bits of information are outliers and have little macroeconomic impact.  But currently, they are growing in number and appear to be having an effect on the stock performance of individual companies/industries.  Cumulatively they can (though not always) be the driving force behind the internal deterioration in Market strength and breadth.  Whether that is happening now is a matter of debate; but it is reaching critical mass as a Market concern.

In addition, the international economic data has been nothing to cheer about whether from China, Japan, the EU or the emerging markets, suggesting that any expectation for outside aid to our own sluggish economy is likely ill founded.

The Fed keeps playing ‘hide the weenie’ over a potential rate hike.  Honestly, I think that they are scared to death that they have waited too long to begin the transition to a normal monetary policy; and as you know, I think that they have every cause to be.  In my opinion, no matter what they do now, it will have negative consequences.  I am not sure but it seems to me that investors are also starting to figure that out.   As you know, I have long maintained that since QE had little to no effect on the economy, its absence will also have little to no effect.  Unfortunately, QE did have a huge impact on the Markets and any negative Fed actions from here will likely have a commensurate impact on them.

Net, net, my two biggest concerns for the Markets are (1) the economic affects of a slowing global economy and (2) Fed policy actions whatever that are or are not.

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 for equities. 

The assumptions in our Valuation Model have not changed either; though at this moment, there appears to be more events (greater than expected decline in Chinese economic activity; miscalculations by one or more central banks that would upset markets) that could lower those assumptions than raise them.  That said, our Model’s current calculated Fair Values under the best assumptions are so far below current valuations that a simple process of mean reversion is all that is necessary to bring Market prices down significantly.

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.
DJIA             S&P

Current 2015 Year End Fair Value*              12300             1525
Fair Value as of 8/31/15                                  12169            1509
Close this week                                               17373            2077

Over Valuation vs. 8/31 Close
              5% overvalued                                12777                1584
            10% overvalued                                13385               1659 
            15% overvalued                                13994                1735
            20% overvalued                                14602                1810   
            25% overvalued                                  15211              1886   
            30% overvalued                                  15819              1961
            35% overvalued                                  16428              2037
            40% overvalued                                  17036              2112
            45%overvalued                                   17645              2188
            50%overvalued                                   18253              2263
Under Valuation vs. 8/31 Close
            5% undervalued                             11560                    1433
10%undervalued                            10952                   1358   
15%undervalued                            10343                   1282

* 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.

No comments:

Post a Comment