The Closing Bell
9/26/15
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 17139-17874
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 2004-2068
Intermediate
Term Uptrend 1920-2713
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 negative---though not so much so among the primary indicators:
above estimates: weekly mortgage and purchase applications, August new home
sales, weekly jobless claims and revised second quarter GDP; below estimates: August
existing home sales, month to date retail chain store sales, August durable
goods orders ex transportation, the September Richmond Fed manufacturing index,
the August Chicago Fed national activity index and revised second quarter
corporate profits; in line with estimates: August durable goods orders, the
September Markit manufacturing and services PMI’s, the September Kansas City
Fed manufacturing index and September consumer sentiment.
The primary
indicators included August new home sales (+), revised second quarter GDP (+), August
existing home sales (-), August ex transportation durable goods orders (-) and August
durable goods orders (0); so evenly matched among these numbers.
Overseas, the data
flow remained lousy. In addition,
Volkswagen admitted to a massive fraud scheme designed to understate emissions
from its diesel models. Estimates of the
fines and potential legal settlements are the billions. This could be big enough to impact the German
economy which has been the engine of EU growth.
‘Could’ is the operative word; but we still need to pay close attention
to developments.
The Fed was active
this week with (1) Yellen sounding more hawkish in a Thursday speech---this
being the first leg of her third or fourth round trip from dovish to hawkish
and back again, and (2) a regional Fed chief saying that zero bound interest
rate policy has been a failure. That
anyone pays any attention to what these guys (gal) are saying anymore is
amazing because we know and they know that (1) it is clear that QEInfinity didn’t
work (2) raising interest rates 25 basis points is irrelevant to the economy,
(3) the only point of Fed policy is to control the Markets and (4) the Fed
seems to be losing that control.
On the fiscal
side, our ruling class is getting perilously close to another government
shutdown. But Boehner appears to have made the ultimate sacrifice to keep it
from happening (this time).
In summary, the
economic stats both here and abroad remained sub-par while the Fed is
scrambling to hold off the ultimate price that will be paid for its ill-conceived
policies. For the time being, I am
staying with our forecast but it appears increasing likely that I will have to
revise it down again.
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.
A neutral and getting less so:
(1)
our energy picture. The discovery of new oil supplies in this
country is a significant geopolitical plus.
However, there has been no ‘unmitigated’ economic positive for the US from
lower oil prices. In addition, lower oil
prices have had a pronounced negative impact in countries in which oil is a
primary export. Loss of oil revenues is
negative for national income and tax receipts and, hence, is a negative for
global growth.
The
negatives:
(1)
a vulnerable global banking system. A quiet week.
‘My concern here.....that: [a] investors
ultimately lose confidence in our financial institutions and refuse to invest
in America 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, particularly in the international financial
system.’
(2) fiscal/regulatory
policy. The odds of a government shutdown continued to rise this week; that is,
until Speaker Boehner resigned. The
reasons that he stepped down primarily seem to be that (1) he could have lost
the speakership anyway and (2) this move will free him to cut a deal with house
democrats to avert a shutdown. Short
term, no shutdown is a plus for the economy.
Longer term, internecine battles in the GOP ranks may make great
theater, but I am not sure what it does for moving the government toward
policies of less spending, less taxes and less 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.
The Fed
continued its strategy to dazzle investors with their footwork and hope that
they don’t notice that there is no there, there. Somewhat surprisingly [or not], in a speech
on Thursday, Yellen switched her stance again---now she is hawkish. In my opinion, this is just more of same ‘data
dependent’ smoke that she blows up our collective skirts in hopes that we think
that she knows what she is doing. When
in reality, she is praying that she can delay recognition that the empress has
no clothes long enough that some miracle bails her and her cohorts out of one
of the worse monetary policies in history. Indeed, earlier in the week, a regional Fed
chief said basically that zero bound interest rates is a failed policy.
My thesis
remains:
[a] QE {except
QEI} has had little impact on the economy; so unwinding it will have an equally
small effect on the economy,
[b] however, QE
led to significant asset mispricing and misallocation; unwinding it will have
an equally significant effect on asset prices,
[c] in any
case, the Fed has once again waited too long to begin the process on monetary
normalization. That compounds their
asset mispricing problem because the Markets appear to be taking matters into
their own hands and they will be less circumspect in correcting the pricing
problem,
[d] the Fed
knows that it has made a mistake, but appears to think that its only
alternative is to bulls**t the Markets and pray for luck. The danger here is that in a desperate
attempt to extricate itself from the problem, it may make another equally
disastrous misjudgment and only make matters worse.
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. The news this week remained focused on Syria
as [a] both Russia and Iran continue to step up their support of the Assad
regime, [b] China appears to be joining them and [c] the refugee problem in
Europe is mushrooming. What concerns me
about this mess is the risk of some accidental confrontation between Russian
and US forces that could escalate.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. This week’s overseas economic
stats included: weaker than anticipated EU and Chinese manufacturing indices,
French unemployment at new highs and August Japanese core CPI fell [how is that
QE working for you, Mr. Abe?]
Signs of
deepening distress in China (medium):
There was one bit
of anecdotal evidence: Volkswagen admitted to having deliberately altered its
onboard software to reflect much lower levels of emissions than mandated. Correcting this fraud is estimated to be
hugely expensive. Further rumors abound
that BMW may get caught up in the same scandal.
Aside from the sheer magnitude of the likely expense to correct the
fraud and deal with any legal matters, the importance is that one of six jobs
in the German economy is related to the auto industry. And remember that Germany is the engine
pulling the EU economy. If this scandal ends
up negatively impacting the German economy, it clearly is not going to help the
EU or global economies.
Further, keeping
QE alive and well, the Norwegian and Taiwanese central banks stayed with the
global QE/currency devaluation theme by cutting key interest rates.
Finally as if the EU doesn’t
have enough problems, Catalonia votes on secession from Spain on Sunday.
In sum, the
international economic news was lousy.
Clearly,
the problems being experienced in the rest of the world keep the yellow
flashing on our global ‘muddling through’ assumption.
Bottom line: the US data continues to reflect very sluggish
growth in the economy. In addition, global
economic trends are still deteriorating; and the Fed remains paralyzed by fear
of the consequences of prior policy mistakes.
The latter two are the biggest economic risks to our forecast. The warning light is flashing.
This week’s data:
(1)
housing: weekly mortgage and purchase applications were
up; August existing home sales were rotten while new homes sales were above consensus,
(2)
consumer: month to date retail chain store sales declined
significantly from the prior week; weekly jobless claims were up less than
anticipated; September consumer sentiment was .1 above expectations,
(3)
industry: August durable goods were in line, however,
ex transportation, they were below estimates; the September Richmond Fed
manufacturing index was very disappointing; the Kansas City Fed index was
slightly improved from August, though still negative; the August Chicago Fed
national activity index declined; the September Markit manufacturing PMI was
fractionally below expectations while the services PMI was slightly above,
(4)
macroeconomic: revised second quarter GDP was a bit
better than the prior reading while corporate profits were worse.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16314, S&P 1931) gave us a split decision on Friday (Dow up, S&P
down). The Dow still ended [a] below its
100 and 200 day moving averages, both of which represent resistance, [b] in a
short term downtrend {17139-17874}, [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 {2004-2068}, [d] within an intermediate term uptrend {1920-2713}
and [e] a long term uptrend {797-2145}.
I thought it
unusual for the S&P not to have more follow through on Friday after the bounce
off of a major trend. That may mean that
it is ready to mount a third challenge to its intermediate term trend. On the other hand, stocks recent
schizophrenic behavior make anything possible.
From a technical standpoint what happens next is important.
Volume rose;
breadth was better. The VIX (23.6) was up slightly, remaining [a] above its 100
day moving average, now support, [b] right on the lower boundary of its short
term uptrend and seems to be tracking its rate of ascent, [c] within an
intermediate term trading range {it remains well above the upper boundary of
its former intermediate term downtrend} and a long term trading range. In addition, it continues to climb above the
20 level.
The long
Treasury rose, closing above its 100 day moving average, still support; and it
ended within short and intermediate term trading ranges. The takeaway is that it remains in a very
short term trading that has existed since the August Market lows. A pattern that is being copied by both oil
and the dollar.
GLD fell,
finishing [a] back below its 100 day moving average, voiding Thursday break,
[b] but remained above 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, [c] within intermediate and long term downtrends and [d] is now
developing a very short term uptrend.
Bottom line: schizophrenia
remains the watch word. As I noted
above, I thought that the S&P’s successful challenge of its intermediate
term uptrend on Thursday would be cause for a re-test of 1970 or at least some
follow through to the upside. There was
none. Does that mean a re-test of the
intermediate term uptrend? Ordinarily, I
would say, yes; especially with the VIX inching higher. Now, it would be just a guess. Time to watch.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16314)
finished this week about 33.7% above Fair Value (12201) while the S&P (1931)
closed 27.6% overvalued (1513). 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 weaken making our already downwardly revised forecast
increasingly suspect. A couple more weeks
of this and I will likely have to lower our outlook even further.
The rest of the
world is in no better shape; in fact, the US is probably the bright spot in the
global economy. I am little bit
concerned that this German auto scandal could act as an accelerant to EU
economic weakness. There is clearly no
proof of that yet; but it is an added risk.
In sum, the US and
global economies are weak and getting weaker.
The risk here is that many Street forecasts are more optimistic than our
own; and if they are revised down, it will likely be accompanied by lower
Valuation estimates.
The Fed was back
to its old game this week---keep investors confused with a lot of empty metaphysical
dialectic so that they won’t notice that it knows that it is in a pickle and
has no notion how to salvage the mess that it is made. After
the Fed declined to raise rates in its September meeting, Yellen said in a
Thursday speech that she was now in the rate hike camp---despite the relentless
flow of lousy economic data. Tortured
logic. But when you consider that the
Fed is more worried about the Market than the economy, it makes all the sense
in the world in view of the selloff that occurred after the aforementioned FOMC
meeting.
That said, we
got a peek under the curtain earlier in the week when one of the regional Fed
heads acknowledged that zero rates are a failed policy. At least someone in that ivory tower gets it. And what is ‘it’? The Fed (1) has pursued a policy that has
created another asset bubble, (2) it has waited too long to attempt to correct
that mistake, (3) and any further policy error move from here runs of the risk making
the problem even worse.
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 they 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.
Thoughts
from a bull (medium):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 9/30/15 12201
1513
Close this week 16314
1931
Over Valuation vs. 9/30 Close
5% overvalued 12811 1588
10%
overvalued 13421 1664
15%
overvalued 14031 1739
20%
overvalued 14641 1815
25%
overvalued 15251 1891
30%
overvalued 15881 1966
35%
overvalued 16471 2042
40%
overvalued 17081 2118
Under Valuation vs. 9/30 Close
5%
undervalued 11590
1437
10%undervalued 10980 1361
15%undervalued 10370 1286
* 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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