The Closing Bell
8/29/15
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 Downtrend 17044-17957
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 Trading Range 2031-2094
Intermediate
Term Uptrend 1898-2671
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%
Economics/Politics
The
economy provides no upward bias to equity valuations. The dataflow
this week was to the negative side of mixed: above estimates: weekly mortgage and purchase applications, month
to date retail chain store sales, August consumer confidence, July durable
goods orders, the July Chicago national activity index, revised second quarter
GDP; below estimates: June new home sales, July pending home sales, the June
Case Shiller home price index, weekly jobless claims, July personal spending,
August consumer sentiment, the August Richmond and Kansas City Fed
manufacturing indices and second quarter corporate profits; in line with
estimates: July personal income.
The primary
indicators included July durable goods (+), revised second quarter GDP (+),
July new home sales (-), July personal spending (-) and second quarter
corporate profits (-). In sum, the
balance of both all the indicators as well as the primary indicators was
negative. However, the anecdotal
evidence was a bit more positive, at least for oil: SLB acquiring another oil
services company and rising oil prices. That
said, the Atlanta Fed again lowered its third quarter GDP forecast.
Overseas, the
Chinese government spent the week intervening in both its stock and currency
markets in an attempt to stem losses. In
addition, the economic data was on balance negative: better numbers from China
(though many continue to have doubts about their veracity), poor stats from
Japan, a failed bond offering in Vietnam and recession in Brazil.
Also this week, the
NY Fed head made some dovish comments. I covered that in our Morning Calls and
re-hash a bit of it below. But the
bottom line is that monetary policy (except for QE1) has not, is not and is not
apt to be of any help to our economy; so debating a rate hike or no rate hike
is a giant circle jerk. All QE has done
is create asset mispricing and misallocation of major portions.
In summary, both
total and primary stats were negative, anecdotal data was mixed to positive,
the Fed is a menace and the global economy provided no relief. For the time being, I am staying with our
forecast but it appears increasing likely that I will have to revise it down
again.
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.
A neutral and getting less so:
(1)
our improving energy picture. Oil production in this country continues to
grow which is a significant geopolitical plus.
On the other hand, there has been no ‘unmitigated’ positive from lower
oil prices. In addition, [a] there is
mounting evidence that the continuing decline in oil prices is at least partly
a function of falling demand and [b] lower oil prices have a pronounced
negative impact on countries in which oil is a primary export and highly leveraged
oil companies. The failure of either or
both would feed the global economic slowdown [deflation] story.
The
negatives:
(1)
a vulnerable global banking system. A week free of bankster misdeeds.
(2) fiscal/regulatory
policy. A week free of ruling class misdeeds.
(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 ‘no rate increase’
crowd received a boost this week from NY Fed chief Dudley, who, in a speech,
accounted as how a rise in the Fed Funds rate was ‘less compelling’ now, given
the turmoil in the international markets.
On the flip side,
long rates have been rising due primarily to the heavy liquidation of Treasury
holdings held in Chinese and emerging market foreign exchange reserves. In addition, these sales have the effect of
tightening money supply [money is spent to buy the bonds]. Clearly, this represents, at least, a partial
usurpation of the Fed’s prerogative to expand or tighten monetary policy. Given the dovish bent of our Fed [i.e. it is
scared sh*tless to make a 25 basis point increase in the Fed Funds rate], it
could potentially lead, believe it or not, to QEIV.
Just to
summarize my continuing theses on Fed policy:
[a] QE rate cuts
had little to no positive effect on the economy, so a rate increase will also
likely have no consequence,
[b] what they
did do was create major distortions in asset pricing and allocation,
[c] even if the
Fed did initiate an increase, a quarter point rise from such a low base wouldn’t
have an impact anyway,
[d] in any
case, the Fed has waited too long to begin the transition from an extraordinarily
accommodative policy; so that when it does undo this mistake, it will likely
result in a lot of pain in the asset pricing and allocation spheres,
[e] keeping perfect
its long term record of never getting its timing right.
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.
(4) geopolitical
risks: the Iranian nuke deal, the secession vote in eastern Ukraine and the hot
war in the Middle East remain the trouble spots. There was only one notable bit of news
related to any of the above; and that was a Ukrainian/creditors deal to write
off a portion of its debt, providing some much needed relief. Nevertheless, all these situations have the potential
to escalate and spill over into the economic arena.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. China held the spotlight this
week which included:
[a] another
small decline in the value of the yuan, accompanied by increasing efforts to stabilize
it, including massive liquidation of reserves to support the yuan,
[b] a dive in
the Chinese securities markets followed by another round of government
intervention in the form of interest rate cuts, enhanced tactics to cower sellers
and new money pumped into the markets,
[c] improvement
in official economic data {electric power generation, leading economic
indicators} but a disturbing report from an outside party that estimates that
the Chinese economic activity is declining.
None of the
above is a plus in that more central government intervention hinders price
discovery and the best and highest use of assets. The worry is that the market will ultimately
prevail and the consequences negatively impact the global economy---like the
report this week that global trade is shrinking.
The impact of Chinese
government meddling (medium):
For the moment, I
am holding to our global economic ‘muddling through’ assumption; but the yellow
light is flashing.
Bottom line: the US economic data continues to reflect very
sluggish growth in the US economy.
However, developments is China reinforce the notion that economic
conditions there are worse than portrayed by official pronouncements. In
addition, the news out of emerging markets reflects rapidly deteriorating economic
conditions. The biggest economic risk to
our forecast is growth problems in the rest of the world. The warning light is flashing.
This week’s
data:
(1)
housing: June new home sales were below expectations; July
pending home sales were below forecast; mortgage and purchase applications were
up; the June Case Shiller home price index was below estimates,
(2)
consumer: July personal income was up, in line, however
personal spending was below consensus; month to date retail chain store sales growth
was up; August consumer confidence was better than anticipated though consumer
sentiment was less; weekly jobless claims fell less than expected,
(3)
industry: July durable goods orders were much better
than forecast, though ex transportation the ‘beat’ was slight; both the August Richmond
and Kansas City Fed manufacturing indices were disappointing; the July Chicago Fed
national activity index was above estimates, but June’s reading was revised
down,
(4)
macroeconomic: revised second quarter GDP improved,
though revised corporate profits were worse.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16643, S&P 1988) finished a stomach churning week with something of a
whimper---the DJIA down fractionally and the S&P up slightly. The Dow ended [a] below its 100 and 200 day
moving averages, both of which represent resistance, [b] in a short term downtrend
{17044-17959}, [c] in an intermediate term trading range {15842-18295}and [d]
in a long term uptrend {5369-19175}.
The S&P
finished [a] below its 100 and 200 day moving averages, both of which represent
resistance, [b] below the upper boundary of a very short term downtrend, [c] in
a short term downtrend {2031-2087}, [d] within an intermediate term uptrend {1898-2661}
and [e] a long term uptrend {797-2145}.
Volume spiked
during the week but fell back near normal levels on Friday; breadth was negative,
with the flow of funds indicator having been negative for almost the entire
week. The VIX broke several trends to the upside and remained there, ending [a]
above its 100 day moving average, now support, [b] within a short term uptrend,
[c] within an intermediate term trading range {it remains well above the upper
boundary of its former intermediate term downtrend and [d] a long term trading
range.
A look at margin
debt (medium):
The long
Treasury performance this week was a bit of cognitive dissonance for me, in
that I am a proponent of the no Fed rate hike/economic slowing camp. The most significant item being that it broke
down below the lower boundary of a very short term uptrend---suggesting a Fed
rate hike and/or a stronger economy is a possibility.
However, as I have
noted, much of the move is being attributed to substantial US Treasury sales by
the Chinese and emerging markets central banks.
While that could certainly mean higher rates in the short term, it
actually supports the notion that the Fed won’t raise rates (if it is as
worried as much about the spillover effects of overseas turmoil as it says). In addition, those Treasury sales are a back
door form of US monetary tightening which suggests an increase likelihood of either
slowing economic growth or another round of QE.
TLT remained [a]
above its 100 day moving average, now support and [b] within short and
intermediate term trading ranges.
GLD rose again, remaining
below its 100 day moving average and within short, intermediate and long term downtrends. However, it traded back above the lower boundary
of its very short term uptrend, voiding the challenge initiated on
Thursday. The odds of a bottom having
been made are up.
Oil was strong
again and broke above the upper boundary of its short term downtrend; if it
remains there through the close on Tuesday, that trend will re-set to a trading
range. It remained below its 100 day
moving average and within short (temporarily?), intermediate and long term
downtrends.
The dollar also
rose, but closed below its 100 day moving average, now resistance, and within
short and intermediate term trading ranges.
Bottom line: after
all that volatility, the indices finished basically flat for the week---though
remember last Friday was a big down day. Nothing occurred that undid the technical
damage done earlier. True, it rendered
the challenges to the DJIA intermediate term trading range and the S&P
intermediate term uptrend void. However,
until there is some test of this very short term uptrend created by the bounce
this week, we can’t really say a bottom has been made. Plus as I noted above, the VIX is in no way
suggesting that the worst is over. Still
my ultimate conclusion remains that the volatility has been so extreme it is
almost impossible to make any meaningful comment on the Market’s direction.
The long
Treasury continues to challenge the notion that there will be no Fed rate hike
and no recession. However, as I noted above,
there are short term outside factors, only tangentially related to the US
economy, driving Treasury bonds down (yields up)---that being selling of
Treasury securities by China and other emerging markets attempting to defend their
currencies.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16643)
finished this week about 36.7% above Fair Value (12169) while the S&P (1988)
closed 31.7% 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. On the other hand, the
turmoil in the Chinese currency and stock market as well as the numbers from
emerging markets are not signs of economic health and that was reflected in
this week’s international trade data. My
primary concern is that American business and labor can’t overcome the hurdles
presented by this problem. Clearly this poses
a risk to the economy, and hence our forecast, and hence, the assumptions in
our Valuation Model.
Here is the
problem stated in more apocalyptic terms (medium):
NY Fed chief
Dudley backed up last week’s narrative from the FOMC minutes, to wit, the
seeming retreat from a September rate hike.
Don’t get me wrong. I don’t think
the FOMC’s decision will make a hill of beans to the economy one way or the
other. What worries me is the complete
loss of investor faith in our Fed as well as the other major central banks in
the world as a result of having pursued an unproven, ineffective, nay, harmful
policy [asset mispricing and misallocation] and the subsequent reaction of the
Markets.
To be fair,
Wednesday’s powerful rally on the same day as Dudley’s speech and the imposition
of strong currency and stock market measures by the Chinese central bank directly
conflicts with that notion. Whether that
rally was a function of those circumstances or simply a dead cat bounce off an
extremely oversold condition will likely be determined this coming week.
Net, net, my two
biggest concerns for the Markets are (1) the economic effects of a slowing
global economy and (2) Fed [central bank] policy actions whatever that are or
are not and the loss of confidence in those actions.
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. Unfortunately,
our assumptions may be too optimistic, making matters worse.
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; turmoil in the emerging markets and commodities; 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 any further bounce in stock 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 16643
1988
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.
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