Saturday, March 19, 2016

The Closing Bell

The Closing Bell


Statistical Summary

   Current Economic Forecast
            2015 estimates

Real Growth in Gross Domestic Product (revised)      -1.0-+2.0%
                        Inflation (revised)                                                          1.0-2.0%
                        Corporate Profits (revised)                                            -7-+5%

2016 estimates

Real Growth in Gross Domestic Product                     -1.25-+0.5%
                        Inflation (revised)                                                          0.5-1.5%
                        Corporate Profits (revised)                                            -15-0%

   Current Market Forecast
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Downtrend                            16613-17351
Intermediate Term Trading Range           15842-18295
Long Term Uptrend                                  5471-19343
                        2015    Year End Fair Value                                   12200-12400

                        2016     Year End Fair Value                                   12600-12800

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Trading Range                          1867-2104
                                    Intermediate Trading Range                        1867-2134
                                    Long Term Uptrend                                     800-2161
                        2015   Year End Fair Value                                      1515-1535
2016 Year End Fair Value                                      1560-1580          

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                          53%
            High Yield Portfolio                                     54%
            Aggressive Growth Portfolio                        53%

The economy maybe providing a temporary upward bias to equity valuations.   It was a big week for stats and they returned to the negative side of the ledger: above estimates: February PPI ex food and energy, the March NY  and Philly Fed manufacturing indices, weekly purchase applications, February housing starts, weekly jobless claims; below estimates: February CPI, ex food and energy, the fourth quarter trade deficit, February leading economic indicators, February building permits, month to date retail chain store sales, March consumer sentiment, January business inventories/sales, the March national homebuilders index, weekly mortgage applications, February industrial production; in line with estimates: February PPI and CPI.

Likewise the primary indicator were downbeat: February housing starts (+), February leading economic indicators (-), February building permits, (-) and February industrial production (-).  In addition, the Atlanta Fed lowered its first quarter GDP growth estimate from 2.2% to 1.9%.  For those keeping a running score, in the last 28 weeks, six have been positive to upbeat, twenty one negative and one neutral. 

Despite this week’s discouraging bias, I am not dismissing the recent two week run of upbeat stats.  If the data were to turn positive again for any sustained time, then they could very well have marked the end of any economic deterioration.  For the moment though, this represents little more than a hope.

On a more upbeat note, oil prices held recent gains and with that, the prospect that a price bottom has been put in.  That in turn inspires some optimism of a pickup in economic activity in the energy sector as well a lessening in the risk of defaults.   I want to repeat that every statistic and analysis of the oil market that I have seen is unsupportive of the notion that the supply and demand of oil will be in balance anytime soon.  Plus history and politics suggest that OPEC will not freeze or lower output.  Nevertheless, Markets have a way of anticipating change.  So I leave open the possibility of an end of the decline in oil prices but would not factor it in to any forecast at this time.

The big news of the week was the last two legs of the central bank trifecta.  Japan kept its QE running full blast though it did leave a move to more negative rates on hold.  The Fed basically walked back most of its move to higher rates, in the process shifting the goal posts on its inflation objective.  Since the Fed statement also emphasized its increased concern about the global economy, some of the guys I pay attention to are suggesting that Yellen has decided to keep money easy in an attempt to help pull the world (China) economy out of recession even if it means letting inflation run hotter than the Fed’s goal.  That is a reasonably worthy objective.  But not to be repetitive, so far the extraordinary QE policy that the Fed has implemented has had almost no impact on the economy; so I really don’t see it doing much good going forward.  Nice try Janet, but no cigar.

On the international economic front, the numbers also returned to their dismal ways, meaning the current trend is even worse than our own.  Hence, there is nothing here to qualify as a positive for our economy.

In summary, the US economic stats this week turned negative again while the international data remained lousy.  Meanwhile, the central bankers have quadrupled down on QE which I expect to have the same impact as earlier editions---which is to say nada.

Our forecast:

a recession or a zero economic growth rate, caused by 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 negatives:

(1)   a vulnerable global banking system.  No news this week.

(2)   fiscal/regulatory policy.  With the election season now in full swing, we are likely to get no new developments by way of fiscal/regulatory policy [except for more empty promises] until at least early 2017.  Without some effort by the politicians, the central banks will left to do are the work which to date has only exacerbated the economic sluggishness.

(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.  

Lots more central bank maneuvers this week.

The Bank of Japan kicked it off by underperforming expectations, to wit, failing to push interest rates further into negative territory though it did promise to keep the QE flowing into the banks.

Japan reels under the pain from negative rates (short):

John Mauldin had an interesting thesis on why the Japanese didn’t cut rates; which, bottom line, was because the Chinese threatened to devalue the yuan, if they did.  The Chinese, in essence saying, stop trying to create external demand via currency devaluation and focus on internal demand via lower interest rates and easier money---or else.  That also seemed to explain our own Fed policy statement this week [i.e. easy money = weak dollar, which keeps the Chinese from having to devalue].

And speaking of the Fed, it confirmed beyond a shadow of a doubt that it is paralyzed with fear.  The statement following its Tuesday/Wednesday meeting was about as dovish as it could be without reversing the December rate hike: [a] it kept rates unchanged and [b] it reduced its expectations for both the level and the rate of increase for future hikes. 

Most of the narrative of how it reached these conclusions was unadulterated bull**t; but in summary [a] the US is economy is fine, but we are reducing our growth expectations, [b] inflation is rapidly approaching our goal but we are going to ignore it for the time being and [c] perhaps the real {only} reason, it suddenly realized that the global economy {especially China} is not doing too well.  Note to Janet: get a clue. This has been going on for a year or more.  All you have to do is read the newspapers.   

Why the Fed is paralyzed (medium):

Finally, the Bank of China reported that it was [a] planning to investment more money in the country’s fixed assets---just what an overbuilt infrastructure needs and [b] considering a tax on currency transactions---a form of capital control.  This along with last week’s proposal to cram down nonperforming bank debt to equity then lend the banks more money suggests a government a lot less confident in its economic forecast than it pretends to be---and I might add, one that is more likely to devalue the yuan no matter whatever the Japanese, Europeans or  the US do.

Adding to this QE love stew, the Bank of Norway lowered its key rate further and indicated that they could soon move into negative territory.

I said last week that ‘Hopefully, the central bankers will recognize the error of their ways and do something helpful---like normalize monetary policy.’  After this week, good luck with that.  From all appearances, these guys have put themselves out on a limb and are now sawing like a lumberjack.  I also said last week.  ‘My hope is that this week’s ECB actions are the beginning of the end.’  I will amend that to read:  My hope is that this last series of central bank maneuvers are the beginning of the end.

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. 

`                       Yellen’s gamble with inflation (medium):

(4)   geopolitical risks: the Middle East remains a quagmire. Iran keeps poking its finger in our eye, daring us to do anything.  Russia is pulling some of its forces out of Syria while Turkey is getting more aggressive there.  This situation has degenerated into a free for all, where every player is or can be a friend or enemy of every other player.  All it takes is a match.

The rationale for Russia’s pullback from Syria (medium):

(5)   economic difficulties in Europe and around the globe.  The international economic stats released this week were again negative:  February Chinese factory orders and retail sales were below expectations;  February Japanese exports and imports both dropped,  machine orders surged and the government lowered its 2016 GDP growth assumption; the Swiss National Bank lowered its inflation forecast and February EU industrial production came in better than estimates.

The Chinese consumer not looking too robust (medium):

The bottom line, like the US dataflow, what we got was not encouraging.  The global economy remains a major headwind.

And in the new updated version of Ground Hog Day, OPEC is scheduling another meeting to discuss a production freeze, this time in Qatar on April 17, but apparently without the participation of Iran.  Looks like we are set up for another round trip in oil and stock prices.  You know, they will keep doing this until it doesn’t work anymore.

In sum, the global economic outlook has not improved.

Bottom line:  this week’s US data points toward a recession, though I continue to stew over whether I acted too quickly in making that call.  The global economy did nothing to brighten the outlook.    Meanwhile, the global central banks are again upping the bet on QE, with no sign that the results will be any different than before.

A deteriorating global economy and a counterproductive central bank monetary policy are the biggest economic risks to our forecast. 

This week’s data:

(1)                                  housing: February housing starts were much better than anticipated, though building permits disappointed; weekly mortgage were down but purchase applications were up fractionally: the March national homebuilders index was below expectations,

(2)                                  consumer: February retail sales were in line, but January was revised down substantially; month to date retail sales grew less than in the prior week; weekly jobless claims rose less than estimates; March consumer sentiment was below projections,

(3)                                  industry: February industrial production fell more than consensus; the March NY and Philadelphia Fed manufacturing indices were well above forecasts; January business inventories rose but largely due to declining sales,

(4)                                  macroeconomic: the February leading economic indicators were up less than expected; February PPI was in line, but ex food and energy, it was less than anticipated; February CPI fell less than estimates but, ex food and energy, it rose more; the fourth quarter trade deficit was larger than consensus.

  The Market-Disciplined Investing

The indices (DJIA 17602, S&P 2049) had a great week as the global central banks turned on the QE afterburners, ending on a triple witch, high volume expiration with improving breadth and plunging volatility.  The VIX (14) is getting close to the lower boundaries of its short and intermediate term trading ranges.  A close in the 10 to 12 price range would represent a good level for the purchase of portfolio insurance.

The Dow closed [a] above its 100 day moving average, now support, [b] above its 200 day moving average, now support, [c] above the upper boundary of a short term downtrend {16613-17351}; if it remains there through the close on Monday, it will reset to a trading range, [c] in an intermediate term trading range {15842-18295} and [d] in a long term uptrend {5471-19343}.

The S&P finished [a] above its 100 day moving average, now support, [b] above its 200 day moving average, now resistance; if it remains there through the close on Monday, it will revert to support, [c] within a short term trading range {1867-2104}, [d] in an intermediate term trading range {1867-2134} and [e] in a long term uptrend {800-2161}. 

The long Treasury continued to inch higher, ending right on the upper boundary of a very short term downtrend.  TLT’s recent hiccup most probably was tied to the strong risk-on trade in equities.  So if the aforementioned very short term downtrend is successfully challenged, then, aside from being a good technical sign for the TLT, it may also be signaling a loss of power of the risk-on trade.

GLD spent the week consolidating after a massive run higher.  In the process, it broke a very short term uptrend, then re-established it.  So the momentum seems to be holding.

Bottom line: the bulls maintained control despite the Market being extremely overbought.  The indices keep overcoming resistance levels and pushing ever close toward their all-time highs.  At this point, I have to assume that those highs will be challenged.   That said, I keep reciting technical factor after technical factor that argue against a successful challenge.  I have no reason the change my mind at this point.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (17602) finished this week about 41.9% above Fair Value (12399) while the S&P (2049) closed 33.4% overvalued (1535).  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 economic data this week failed to maintain that brief stint of upbeat stats.  I can’t say that that short positive trend is over; but I can’t say that it is not.  What I can say is that twenty one out of the last twenty eight weeks have depicted an economy whose rate of growth, at best, is declining and, at worst, is nonexistent.  Not helping matters are (1) the US corporate revenue, earnings and dividend data which is deteriorating and (2) the global economic data. 

Of course, the recovery in oil prices, if they hold, will be a positive for the energy and banking sectors.  But that may not be enough to offset slowdown in business activity both here and abroad; and it almost certainly won’t be enough to support many Street forecasts.  If I am correct, then those forecasts will have to be revised down; and when that occurs, it will likely be accompanied by lower Valuation estimates. 

That said, investors are partying like it’s 1969 following the central bank hat trick scored over the past week. Every central banker on the planet is driving to the easy money hoop in one way or another, be it lower interest rates or injections of more liquidity.   I, on the other hand, remain a party pooper: (1) I can’t believe these bankers would be getting as aggressive as they are unless they thought that the global economy was in a lot worse shape than they are letting on [or in their forecast], and (2) I might not be as skeptical if someone would try something different to correct this current malaise; but they are not.  All the global economy is getting is another dose of the same medicine that has done nothing to date to cure the patient. 

Unfortunately, as long as this ill-conceived euphoria lasts, mispriced assets will remain in nosebleed territory. 

When it ends, I believe that the cash generated by following our Price Discipline will be welcome as investors wake up to the Fed’s (and other central bank) malfeasance because I suspect the results will not be pretty. 

Net, net, my two biggest concerns for the Markets are (1) declining profit and valuation estimates resulting from the economic effects of a slowing global economy and (2) the unwinding of the gross mispricing and misallocation of assets following the Fed’s wildly unsuccessful, experimental QE policy.

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; turmoil in the emerging markets and commodities; miscalculations by one or more central banks that would upset markets; a potential escalation of violence in the Middle East and around the world) 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 2016 Year End Fair Value*              12700             1570
Fair Value as of 3/31/16                                  12399            1535
Close this week                                               17602            2049

Over Valuation vs. 3/31 Close
              5% overvalued                                13018                1611
            10% overvalued                                13638               1688 
            15% overvalued                                14258               1765
            20% overvalued                                14878                1842   
            25% overvalued                                  15498              1918   
            30% overvalued                                  16118              1995
            35% overvalued                                  16738              2072
            40% overvalued                                  17358              2149
            45% overvalued                                  17978              2225

Under Valuation vs. 3/31 Close
            5% undervalued                             11779                    1458
10%undervalued                            11159                   1381   
15%undervalued                            10539                   1304

* 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