The Closing Bell
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product (revised):
+1.0- +2.0%
Inflation
(revised): 2.5-3.5 %
Growth
in Corporate Profits (revised): 5-10%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation 2.0-2.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 13265-14035
Intermediate Up Trend
12457-17457
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
2011 Year End Fair Value 10750-10770
2012 Year End Fair Value
11290-11310
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Up Trend 1415-1505
Intermediate
Term Up Trend 1312-1912
Long
Term Trading Range
766-1575
Very
LT Up Trend 651-2007
2011 Year End Fair Value
1320-1340
2012 Year End Fair Value 1390-1410
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 24%
High
Yield Portfolio 25%
Aggressive
Growth Portfolio 27%
Economics/Politics
The
economy is a modest positive for Your Money. The economic data this week was basically negative
highlighted by an especially lousy durable goods number. Positives: weekly retail sales, consumer
confidence, weekly jobless claims, weekly mortgage and purchase applications
and the September Richmond Fed manufacturing index. Negatives: the Chicago national activity
index, the Dallas Fed manufacturing index, the Case Shiller home price index,
August new home sales, August durable goods orders, Chicago PMI ,
the University of Michigan’s final September consumer sentiment index, August
personal income and the revised second quarter GDP
figure Neutral: August personal spending
and core PCE.
This is the
second week in a row of overall disappointing stats; and as I noted above,
particularly distressing was the durable goods report. On the other hand, Friday’s personal income
and spending numbers were up---and remember that the consumer is 75% of the
economy. Two weeks of poor data
certainly don’t mean a recession is on its way; but it is cause to raise the
alert level to amber. For the moment, I
am not altering our forecast:
‘a below average secular rate of recovery
resulting from too much government spending, too much government debt to
service, too much government regulation, a financial system with an impaired
balance sheet. and a business
community unwilling to hire and invest because the aforementioned along with
the likelihood a rising and potentially corrosive rate of inflation due to
excessive money creation and the historic inability of the Fed to properly time
the reversal of that monetary policy.’
The pluses:
(1)
talk about bad timing.
I pulled the recession call of the ECRI from our list of risks last week
on the thesis that not only had it not had declined in seven weeks [in fact, it
was up again this week], its founder’s predictions notwithstanding, but also
because the ‘big four’ measures of the economy were showing little sign of
recession. Well, this week’s review of
that indicator is now suggesting a risk that the economy could be stumbling. It is not making a recession call, but the
new readings clearly adds weight to elevated alert status I mentioned
above. Of course, this may be just a
hiccup. Nevertheless, it does start
moving this ‘plus’ factor towards ‘neutral’.
(2) the seeming move of the electorate towards embracing fiscal
responsibility. I have argued that means
a Romney/Ryan November victory which should be more conducive to fixing the
monetary/fiscal/regulatory problems that plague this economy than an Obama win. Unfortunately, Romney had another poor week
campaigning; and if he doesn’t get his s**t together and quickly, he is going
to default this election to Obama.
Hence, this factor is fading as a positive.
The latest intrade results (short):
Notice how both
our positives on the economy are becoming less so. This doesn’t help my mood, improve my outlook
for the economy or make me want to own more stocks.
The negatives:
(1) a vulnerable banking system.
More details regarding the Libor rate setting scandal came out this
week. By itself, this transgression is
not going to sink the banks; but it is symbolic of the greed and disregard for
the rules that has typified the financial industry for the last decade. My concern here is 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 a collapse of the EU financial system.
(2) a blow up in the Middle East . The Syrian civil war grinds on; and Israel Iran US
I am not sure
where that all leads; but I am reasonably sure that it won’t be to a more
stable Middle East .
If that is the case, then one of the consequences is almost assuredly
higher oil prices which, at the least, will act as a hindrance to US
(3) now that the harvest season is in full swing, the focus on weather
generated commodity/food inflation seems
to be waning. Grain prices have
flattened out but remain well above levels of six months ago while meat prices
are flat and in some cases down. That
said the lower meat prices are a function of the premature slaughter of animals
due to high feed costs; and that ultimately will lead to higher meat prices.
(4) ‘another week, nothing done on the ‘fiscal
cliff’ and no prospects anytime soon. As
you know, my position on the ‘fiscal cliff’ as it currently exists is that in
the end, the scheduled tax increases and spending cuts will not occur; or if
they do, they will be quickly reversed.
Whoever wins in November will do something in January to alter this
outcome---we just don’t what that will be.
That said, the risk here is that the above
assessment is dead wrong; that is, we once again end up with a split
government, both parties decide to play chicken and push the US
The other problem which I introduced several
weeks ago is the potential rise in interest rates and their impact on the
fiscal budget. As I noted, the US GDP .
In the meantime, the inability of our
political class to focus on anything but its own re-election contributes to the
fear and uncertainty among businesses and consumers and by extension their
willingness to spend, invest and hire.’
Pimco on the ‘fiscal cliff’ (medium):
(5)
rising inflation: the potential negative impact of
central bank money printing. Draghi and
Bernanke went ‘all in’ for monetary easing a couple of weeks ago. Japan China
The risk of a
massive global liquidity infusion is, of course, inflation. The bulls argue that thus far, all this money
has gone into bank reserves [meaning it has not been spent or lent], that as
long as banks are too scared to lend and businesses to borrow, it will remain
unspent and unlent and therefore will have no inflationary impact. And they are absolutely correct. But the whole point of the Fed’s exercise is
to encourage banks to lend and businesses to invest. So on the off chance that plan works,
inflationary pressures will grow unless the Fed withdraws the aforementioned
reserves before inflation kicks in.
And therein
lies the rub. [a] Bernanke has already
said that when it comes to balancing the twin mandates of inflation versus
employment, he would err on the side of unemployment {that is, he won’t stop
pumping until he is sure unemployment is headed down}. That can only mean that the fires of
inflation will already be well stoked before the Fed starts tightening and [b]
history clearly shows that the Fed has proven inept at slowing money growth to
dampen inflationary impulses---on every occasion that it tried. Why will this time be any different?
(7)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
This week was marked by riots in Spain Greece
Of course, as
long as voters and investors go along with this charade, a ‘muddle through’
scenario will remain operative.
Unfortunately, there are a number of problems: [a] the continent by all
measures is slipping into recession; and that will make it all the more
difficult for the eurocrats to make credible economic growth assumptions that
investors and voters will swallow, [b] this week’s protests suggest that the
unwashed masses have already had enough. If so, then time is running out on the
eurocrats to come up with a real solution.
I believe that
the above argues that the European ‘tail risk’ has not gone away as many
investors now do. That ‘tail risk’ is
that investor patience wears thin and they trash the eurobond/eurocurrency
markets, creating a crisis that is beyond the eurocrats’ capability to
resolve---a likely outcome of which will be a freezing up of the entire
financial system which infects our own [via counterparty risk in credit default
swaps].
The latest
from Spain
Bottom line: the US US
Not helping is
the current hesitancy to spend and invest due to uncertainty over future
regulatory and tax policies as well as the ‘fiscal cliff’. This condition will likely remain unchanged
until after the election; and even then could continue depending on the new
balance of power. In the meantime, the
Fed is running the presses 24/7 adding daily to risk of future inflation.
Finally, the EU is
doing what it does best which is lie to its citizens for the sake of preserving
a bureaucratic wet dream. I am not smart
enough to know what happens next; but I do believe that unless the eurocrats
get real with their citizens and their policies---and soon, the end will be
uglier than I am now assuming.
For the moment, this
is all reflected in our Models.
This week’s
data:
(1)
housing: both the weekly mortgage and purchase applications
increased; the July Case Shiller home
price index was up but less than estimates;
August new home sales were below expectations,
(2)
consumer: August personal income was below forecast;
both personal spending and core PCE were in line; weekly retail sales were up; weekly
jobless claims declined more than expectations; September consumer confidence
spiked higher but the University of Michigan’s final September reading of
consumer sentiment was below both estimates and August’s report,
(3)
industry: August durable goods orders were horrendous; the
September Dallas Fed manufacturing index came in well below expectations while
the comparable Richmond Fed’s index rose much more than anticipated; the
September Chicago PMI fell dramatically,
(4)
macroeconomic: second
quarter GDP was up 1.3% though it was
revised down from up 1.7%; the Chicago
The Market-Disciplined Investing
Technical
This week, the indices
(DJIA 13437, S&P 1440) closed within two primary trends: (1) their short
term uptrends [13265-14035, 1415-1505] and (2) their intermediate term uptrends
[12457-17457, 1312-1912]. Resistance
exists at the old 2007 highs of 14190/1576 and support at the April 2012
resistance turned support level of 13302, 1422.
The S&P traded below the 1442 minor support level for the second
time on Friday. That re-starts our time
and distance discipline.
Volume on Friday
rose while breadth declined. The
underlying technical strength of the Market continues to deteriorate with the
flow of funds, on balance volume and our own internal indicator weakening again
this week. The VIX rose but remains
below the upper boundary of its short term downtrend and above the lower
boundary of its intermediate term trading range.
More divergences
(short):
GLD was down
fractionally, finishing above the lower boundaries of its (1) very short term
uptrend, (2) short term uptrend and (3) intermediate term trading range. The recent move up has brought GLD close to the
175.5 upper boundary of the intermediate term trading range.
Bottom
line:
(1) the DJIA and S&P are in uptrends, both in the short term
[13265-14035, 1415-1505] and the intermediate term [12457-17437, 1312-1912],
(1)
long term, the Averages are in a very long term [78
years] up trend defined by the 4546-15148, 651-2007 and a shorter but still
long term [13 years] trading range defined by 7148-14198, 766-1575.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (13437)
finished this week about 20.0% above Fair Value (11165) while the S&P (1440)
closed 4.2% overvalued (1382). Incorporated
in that ‘Fair Value’ judgment is a ‘muddle through’ scenario in Europe
and a sluggish recovery at home that isn’t likely to improve until we change
the personnel in Washington
The economy
continues its slow. plodding progress---although this week made the second in a
row of disappointing data. This is too
short a timeframe to warrant altering our forecast but not too soon to be on heightened
alert.
As you know, I
have been hopeful that the chances of ‘a change in personnel in Washington
Of course, it is
never over till its over. But if the
electorate chooses a nanny state over a capitalist one, then our short term
forecast (higher taxes, higher government spending, more regulation and an
activist monetary policy) will transition into a long term outlook. That means slower economic growth and a less
friendly environment for Your Money. To
be sure, large corporations (and hence their earnings) may do just fine. After all, they have plenty of money to rent
seek from an increasing receptive political class.
But that doesn’t
necessarily translate to a positive for Your Money. That is the reason that I have began
investigating strategies for survival. I
am doing nothing different (to some extent our GLD and foreign ETF positions
already reflect my concerns) until we know the November election results. But if Obama wins, my efforts will become
much more active.
All that said, the probability of
severe economic dislocations in Europe remains the biggest
risk in our forecast. Investor euphoria
over Draghi’s new ‘all in’ policy notwithstanding, I am not sure how much has
really changed nor that any ‘tail risk’ has been removed. Supporting that notion, this week (1) the
Spanish parliament came up with an austerity plan that on the surface meets EU
standards but mathematically is more of the same---make promises that you know
you can’ keep, fail, make more promises that you can’t keep, fail again, rinse
and recycle, (2) Spain erupted in protests and the Catalonia region joined
Basque threatening to secede, (3) Greece failed to meet its latest austerity goals,
appealed for more money, made some more promises that it won’t keep and as a
just reward had to contend with more rioting.
I don’t know about you; but after all
that, I am hard pressed to assume that Draghi has the situation under control,
that everyone is going to cooperate and the EU will live in fiscal harmonious
bliss forever more. On the other hand, as long as most investors buy the pack
of lies and delusions that the eurocrats are selling, ‘muddle through’ will be
the operative scenario. And as long as
that occurs, it gives the eurocrats more time to develop and implement a real
‘muddle through’ solution.
Of course, the preceding pretty much
describes our forecast; and given that outlook, our Model has the Market (as
defined by the S&P) priced modestly overvalued. That would normally warrant
a cash holding of around 15% but with a smaller GLD position. So clearly, I have concerns---the primary
being this European problem, in particular the ‘tail risk’ associated with the
potential failure of the eurocrats to prevent any of the PIIGS outside of
Greece from imploding and the economic downside should that occur. As a result, our Portfolios are heavier in
both cash and GLD than they might otherwise be.
At the moment, that puts me on the wrong
side of the Market. But I believe that
stocks are being driven by a false euphoria generated by the ‘all in’ of the
major global central banks and that ultimately, in Gary Kaminsky’s words, ‘this
thing is going to end ugly’.
‘My
investment conclusion: stocks (as
defined by the S&P) are overvalued (as defined by our Model). I have no clue how long this will go on; but
as long as it is driven by easy monetary policy, it is a Market that is too
risky for me to play.
To be clear, the economy is performing as I
expected; as are corporate profits. So
in the absence of any of the risks enumerated in the Economics section
manifesting themselves, I am not worried about the fundamentals. My decision to not chase stocks is based
strictly on price. So all things remaining
equal, if stocks drop 10-12% in price, our Portfolios will be Buyers.’
This week our Portfolios added to their
GLD position; while the High Yield Portfolio lightened up its holdings of NUS
and KMB .
Bottom line:
(1)
our Portfolios
will carry a high cash balance,
(2)
we continue to include gold and foreign ETF’s in our
asset mix because we continue to believe that inflation is a major long term
risk. An investment in gold is an
inflation hedge and holdings in other countries provide exposure to better
growth opportunities. However, the
likelihood of a continued strengthening in the dollar argues for less emphasis
on these investment alternatives over the intermediate term.
(3)
defense is still important.
DJIA S&P
Current 2012 Year End Fair Value*
11300 1400
Fair Value as of 9/30/12 11165 1382
Close this week 13437 1440
Over Valuation vs. 9/30 Close
5% overvalued 11723 1451
10%
overvalued 12281 1520
15%
overvalued 12839 1589
20%overvalued 13398 1658
25%
overvalued 13956 1727
Under Valuation vs. 9/30 Close
5%
undervalued 10606 1312
10%undervalued 10048 1243 15%undervalued 9490 1174
* 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
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 40 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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