The Closing Bell
10/6//12
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 13304-14042
Intermediate Up Trend
12501-17501
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 1425-1515
Intermediate
Term Up Trend 1317-1917
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 witnessed a return
to a more mixed to positive trend:
Positives: weekly mortgage and purchase applications, September vehicle
sales, the August ADP private payroll
report, the September unemployment rate and both the September ISM
manufacturing and nonmanufacturing indices.
Negatives: weekly jobless claims, August construction spending and
factory orders. Neutral: weekly retail
sales as well as September chain store sales; September nonfarm payrolls.
After two weeks
of some pretty disappointing economic data, the stats improved this week
highlighted by the strong performance of both ISM indices and the fall in the
unemployment rate. I thought the ISM
reports particularly important because much of the poor numbers in the prior two
weeks were concentrated in the industrial sector.
Of course, the
lower unemployment rate is equally important if it is a real figure. As you probably know, on Friday the main
talking point on the financial news channels was whether the 7.8% reported
unemployment rate was real, a statistical anomaly or fudged for political
purposes.
I am not calling
bulls**t on this number; but some pundits are---finding it extremely unusual
that the unemployment rate just happens to drop to one tenth below the number
when Obama took over a month before the election. That said, assuming 7.8% is the proper measure,
it does nothing to change our economic forecast either short or long term; and
if Mr. Bernanke is to be believed, it will do nothing to slowdown the speed of
the printing presses. So while the
political debate about the veracity of the unemployment figure may be
entertaining, in my opinion, it is meaningless in the scheme of things.
Update of big
four economic indicators (medium):
The net effect
of all this is to lower the economic alert level which I raised last week. As always I am hesitant to make any major
adjustments after a single week’s data; so I am not going to turn the warning
light off just yet. But it appears that the prior two weeks may have
represented a brief hiccup. That would
mean that the stats continue to confirm 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) our improving energy picture.
The US
(2) the seeming move of the electorate towards embracing fiscal
responsibility. Kudos to Romney for a
good debate performance. That said, if
he retreats into his Casper Milquetoast routine like he did after the Ryan
nomination, it will have been for nothing.
The hope for a more fiscally responsible, less regulatory obsessed
administration now rests on follow through.
The negatives:
(1)
a vulnerable banking system. JP Morgan took it in the snoot again this
week as the NY AG file suit against it for fraud in derivatives markets. However, after getting behind the headlines, it
appears that this move has more politics than legal liability in it---the AG is
suing JPM for actions of Bear Stearns which
the government begged JPM to bail out. In addition, the prior AG had declined to
prosecute.
Even assuming
no wrong doing on JPM ’s part---which I am
quite willing to do---this lawsuit adds one more vulnerability to the banking
system, to wit, the big banks are high profile targets that every politically
motivated lawyer in the country may be looking to take a shot at. To be sure, the banks deserve it. But it is enough of a distraction from making
loans while spending resources defending themselves against lawsuits that are
warranted; there is no telling how much greater it will be if the banks are being
piled on by every politically motivated, jerk off lawyer in the country.
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)
‘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.’
(3)
rising inflation:
[a] the potential negative impact of central bank money printing. Draghi and Bernanke went ‘all in’ for
monetary easing a couple of weeks ago.
Japan and China soon joined the parade.
This week Australia and South Korea followed suit. So the competitive devaluation race continues
a pace.
‘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, i.e. QEIII, is to encourage banks to lend and
businesses to invest. So on the off
chance that the 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 {and he
reiterated it this week} 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?
Central banks
gone wild (a bit long but today’s absolute must read):
[b] a blow up in the Middle East . Syria Turkey Tehran Israel
That said, I am
not sure where that all leads; but clearly the probability of a negative event
is rising. 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 US Middle East .
The
irony of the sanctions against Iran
Now they are
rioting in Bahrain
[c] now that the harvest season is in full swing, it appears that the
corn crop is coming in better than expected.
So the focus {fear} 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.
I am not sure
how much of the higher grain prices are already in the food chain but clearly
the approaching rise in meat prices is not.
(4)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
Not much happened this week other than Draghi pounding his ‘all in’ drum
and Spain Spain
Meanwhile, Greece
Of course, as
long as voters and investors go along with this charade, a ‘muddle through’
scenario will remain operative. But that
doesn’t mean that the European ‘tail
risk’ has not gone away. So while our
forecast remains that the EU will somehow ‘muddle through’, the risk of that
not occurring is still substantial and the downside to stocks if it doesn’t
occur remains considerable
Bottom line: the US
While the
political class did nothing to help this scenario this week, investors/voters
did get a psychological boost from the Romney debate performance. I think that in and of itself, it will have
little impact. However, if it is a sign
of more aggressive behavior by Romney, a sign that he will start calling out
Obama on His policies, a sign that he will strive to make a clear distinction
between ‘economic patriotism’ and free markets, then the GOP has a chance to
take the November elections. But that is
just a first step, it then has to deliver on lower taxes, lower spending, lower
regulation and firing Bernanke. Until we
get some sign that those things will occur, our long term forecast will be no
different from our current outlook.
In the meantime,
the Fed is running the presses 24/7 and Bernanke restated this week his
intention to keep them running until employment shows substantial improvement.
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
soared,
(2)
consumer: weekly retail sales were mixed while
September chain store sales were positive as were vehicle sales; weekly jobless
claims rose while the September ADP private
payroll report showed a larger increase than forecast and September nonfarm
payrolls were in line; the unemployment rate dropped to 7.8%,
(3)
industry: both the September ISM manufacturing and
nonmanufacturing indices were well ahead of expectations; though August
construction spending and factory orders were disappointing,
(4)
macroeconomic: none
The Market-Disciplined Investing
Technical
This week, the indices
(DJIA 13610, S&P 1460) closed within their two primary trends: (1) their
short term uptrends [13304-14042, 1425-1515] and (2) their intermediate term
uptrends [12501-17501, 1317-1917]. Additional
resistance exists at the old 2007 highs of 14190/1576 and support at the April
2012 resistance turned support level of 13302, 1422. On a more short term basis, the Averages have
been flat over the last two weeks and have formed some resistance circa 13653/
1469 (note that on Friday, the indices challenged this level but backed off). Also the S&P has minor support at around 1442.
Volume on Friday
fell while breadth (advance decline, flow of funds, up/down volume, and our
internal indicator) was mixed. The VIX dropped
sufficiently intraday to trade below the lower boundary of its intermediate
term trading range; however, it rebounded dramatically to close above this
support level and below the upper boundary of a short term downtrend. That keeps this indicator ‘neutral’.
GLD was down, finishing
right on the lower boundary of its very short term uptrend. A bounce here should set GLD up for an
assault on the upper boundary of its intermediate term trading range. A further
decline could lead to a test of the lower boundary of its short term
uptrend. GLD also closed above the lower
boundary of its intermediate term trading range.
This is a must
read (medium):
Bottom
line:
(1) the DJIA and S&P are in uptrends, both in the short term [13304-14042,
1425-1515] and the intermediate term [12501-17501, 1317-1917],
(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 (13610)
finished this week about 21.4% above Fair Value (11210) while the S&P (1460)
closed 5.2% overvalued (1388). 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 to plug along. This week’s
largely upbeat data ends two weeks of disappointing stats. This kind of erratic behavior in the economic
reports is to be expected when growth is well below the historic secular trend
in particular when the reasons for that sub par performance are excess
government intervention in fiscal, monetary and regulatory affairs.
As you know, that
is the reason that I included as part of my forecast the stipulation that we a need for ‘a change
in personnel in Washington
However, as I
have opined repeatedly the last two days, that will likely only buy him some
benefits for a day or two. If there is
no follow through, Romney will be no closer to the White House and the
political economy will be no closer to a ‘change in personnel’ than it was a
week ago.
At the moment,
all we can do is wait for developments.
As a final note, I will say that in the absence of a ‘change in
personnel’ our forecast for a sluggish economy growing below its historical
secular rate will likely become our forecast for the next five years.
All that said, the probability of
severe economic dislocations in Europe remains the biggest
risk to our outlook. Draghi’s new ‘all
in’ policy notwithstanding, Greece Italy
Yet hope springs eternal. Investors continue to give the eurocrats the
benefit of the doubt; and as long as they do ‘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.
That
is our forecast; but as you know, I don’t feel enormous confidence in its
occurrence primarily because (1) with all due respect to Draghi et al, nothing
substantive has really been proposed to address the EU sovereign/bank debt
problems and (2) while there is no precise way of knowing the extent of the
damage to the global economy and its banking system of a Spanish bankruptcy, it
is largely because the hole is so deep, we can’t see the bottom.
As a result, our Portfolios are
carrying an abnormally high level of cash for a Market that is only about 5%
overvalued (as defined by the S&P).
Further, their GLD positions are nearly twice their usual size. Finally, my focus is on our Sell versus our
Buy Discipline.
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’.
Here is some real food for thought: the return from shorting an S&P
700 put is equal to buying a US Treasury bond (medium):
My investment conclusion: stocks (as defined by the S&P) are
overvalued (as defined by our Model). However, making this slightly overvalued
situation much more hazardous is that (1) enormous ‘tail risk’ exists if the EU
sovereign/debt crisis are not properly addressed and (2) prices seem to be
driven largely by the fear of fighting a far too easy, money printing Fed. I have no clue how long this will go on; but
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.’
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 10/31/12 11210 1388
Close this week 13610 1460
Over Valuation vs. 10/31 Close
5% overvalued 11760 1457
10%
overvalued 12331 1526
15%
overvalued 12891 1596
20%overvalued 13452 1665
25%
overvalued 14012 1735
Under Valuation vs.10/31 Close
5%
undervalued 10649 1318
10%undervalued 10089 1249
15%undervalued 9528 1179
* 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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