The Closing Bell
3/19/16
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%
Economics/Politics
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
Technical
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.
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