The Closing Bell
10/20//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 (?) 13462-14293
Intermediate Up Trend
12593-17593
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 (?) 1445-1537
Intermediate
Term Up Trend 1327-1925
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 the best that we
have had in a long time: Positives: weekly
purchase applications, September retail sales, September industrial production;
September core CPI ; the September leading
economic indicators and the Philly Fed manufacturing index. Negatives: weekly jobless claims, weekly
mortgage applications, the NY Fed manufacturing index, September existing home
sales and September CPI . Neutral: weekly retail sales; August business
inventories and sales.
The important
numbers were September retail sales, September industrial production, September
leading economic indicators---all of which came in better than expected---and
weekly jobless claims---which was a disappointment. So score it three to one for the good guys.
This data is
another important sign that the risk of recession is receding. It could also be a signal that the economic
growth rate could pick up in 2013---‘could be’ being the operative words. As I often say, one week’s data does not a
trend make; so we really must wait for additional quantitative support before
considering an upgrade to our estimates.
However, if we get another week or two of the kind of upbeat stats we
received this week, then I may consider adding ‘an improving long term growth
rate’ to our list of Pluses.
That said, any
increase will be a modest one for one simple reason: the growth stunting
problems of excessive debt creation, too much easy money and an over regulated
economy have yet to be dealt with and until they are, we are stuck with anemic
economic growth,
Furthermore, as
I mentioned in Wednesday’s and Thursdays’ Morning Calls, our 2013-2015 outlook
is more dependent than anytime in my memory on the outcome of an election.
An Obama victory
would insure a continuation of below average secular growth; but with the
caveat that at some point, even more fiscal, monetary, regulatory excesses will take their toll, resulting in an even
more stagnant economy or worse.
A Romney
success, assuming he fulfills his election promises (again a key operative
statement) would likely mean a slowdown or even a mild recession as fiscal and
monetary policies are brought back in line with economic reality. On the other hand, that would set the stage
for the economy to return to its historical secular growth path likely starting
in late 2014 or early 2015.
And (medium):
However, since
this election appears to be a toss up, I am going to wait for the outcome
before considering any revisions to our 2013 forecast. That has the added benefit of a couple more weeks
of data to either confirm or not an increase in the level of economic activity.
All that said,
for the time being, our forecast remains:
‘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.’
Update of big
four economic indicators (medium):
The pluses:
(1) our improving energy picture.
The US US Middle East
oil dramatically enhances our flexibility in strategic planning.
(2) the seeming move of the electorate towards embracing fiscal
responsibility. Romney/Ryan have at last
began taking a firm stand on the issues and it shows in the polling
results. This is not to say that they
will win. And it is not to say that if
they do win, they will take the steps necessary to get control of the federal
budget, stop the explosion of fiat money and reduce the regulatory burden that
has been imposed on the electorate in the last four years. But it could be a start; and every long
journey begins with a first step as proverb goes.
I hate being
cynical about my country; but from an investment standpoint, I believe it
necessary in order to protect Your Money.
Hence, given the long history of both political parties subordinating
the public good to their private objectives, I don’t think it wise to assume
our economic problems are solved by a Romney/Ryan victory. They must prove themselves with actions not
words before I will consider altering our strategy and asset allocation. So I keep this on our list of positives but
driven primarily by hope.
The negatives:
(1) a vulnerable banking system.
State’s Attorneys’ General continue to file suit against the banks for
various and sundry offenses. But there
has been no new dramatic revelations of wrong doing or accounting shenanigans.
However, the big banks remain too big to fail, their willingness to assume risk
in their investment banking/trading operations appears undiminished and their
balance sheets remain as opaque as ever.
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’ has been 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 be able to forge a compromise do something in January to alter
this outcome.
That position
took a blow this week as Obama vowed to veto any proposed solution to the
‘fiscal cliff’ that didn’t include higher taxes on the wealthy---something that
has been an anathema to the Republicans to date. So it would appear that unless one party or
the other makes a clean sweep in the elections, the political calculus may be
setting up for a world class game of chicken, with the outcome much less
certain than suggested in the previous paragraph.
A problem
related to the ‘fiscal cliff’ is the potential rise in interest rates and its
impact on the fiscal budget. As I have noted
previously, the US
Making matters
even worse, under QEIII the Fed is adding another $40 billion a month in
mortgages to its balance sheet.
So the risk here is two fold: [a] to the
Fed---its balance sheet is levered to the point that Lehman Bros. looks like it
was a AAA credit. So if interest rates
go up {and prices go down}, the very thin equity piece of the balance sheet
would disappear. The Fed would then be
technically bankrupt. and [b] to the Treasury---it must pay the interest
charges. Hence, if rates go up, the
interest costs to the government go up; and it they go up a lot, then this
budget line item will explode and make all the more difficult any vow to reduce
government spending as a percent of GDP .
(3)
rising inflation:
[a] the potential negative impact of central bank money printing. Draghi and Bernanke went ‘all in’ for
monetary easing and have been joined by the central banks of Japan China Australia South Korea
‘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 {twice} 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?
[b] a blow up in the Middle
East . Al Qaeda is
assassinating foreign diplomats across the region, there is now enough military
might cruising the Persian Gulf to reenact the Battle of
Midway and Israel
None of this is
to say that a disaster or war is eminent; but clearly the tensions are high
enough that if one party missteps, the odds of some kind of confrontation are
not de minimus. 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 expansion and, at the worse, could
well push the economy into recession and add fuel to inflationary impulses And this says nothing about the US being
drawn into yet another ground war in the Middle East.
[c] now that the harvest
season is in full swing, it appears that the corn crop is coming in better than
expected. Ag commodity prices has
stabilized {except for hogs} though at levels well above six months ago; and we
are starting see those higher prices impact on producer costs in their third
quarter earnings reports. However, it
is not yet clear how much of this ultimately gets passed on the consumers. But we will know soon enough.
(4) finally, the sovereign and
bank debt crisis in Europe remains the biggest risk to
our forecast. Not much happened this
week by way of dealing with the severe difficulties facing Greece Spain
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 gone away. So while our
forecast remains that the EU will somehow ‘muddle through’, the risk of that
not occurring is still substantial and growing.
Bottom line: the US
That said, this
would not be a return to historical secular growth rates. Our deficit is still too big; our debt is
still too large; the Fed remains out of control; and our tax and regulatory
environment still too oppressive.
Correcting those problems will take time and involve some pain and may
not even happen if Obama is re-elected or Romney doesn’t live up to his
campaign promises.
The political
class did nothing to help this scenario this week. Quite the contrary, Obama upped the ante on
the ‘fiscal cliff’ by pledging to veto any measure that didn’t include tax
hikes on the ‘rich’.
On the other
hand, Romney is making the right noises and if elected will hopefully follow
through with a more fiscally responsible agenda. However, as you know, I regard this with
healthy skepticism, given the historical performance of the GOP. I am not saying his routine is all
bulls**t. I am saying actions speak
louder than words; and until we get action, our forecast will remain unchanged.
In the meantime,
the Fed is running the presses 24/7. No matter who wins the election, we are
likely looking at rising inflation next year.
Longer term, barring a miracle, this whole QE process is likely to end
very badly, in my opinion.
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.
Why Rajoy’s
strategy won’t work (medium):
Why nothing is
working (medium):
For the moment, this
is all reflected in our Models.
This week’s
data:
(1)
housing: weekly mortgage applications fell but purchase
applications were up; September housing starts and building permits soared
while existing home sales dropped,
(2)
consumer: weekly retail sales were OK but September
retail sales were quite positive; weekly jobless claims rose dramatically,
(3)
industry: the October NY Fed manufacturing index came
in worse than expected while the Philly Fed index was stronger than estimates;
August business inventories were a bit stronger than anticipated, but sales
were not as good; September industrial production was twice forecasts,
(4)
macroeconomic: September CPI
was hotter than estimates though core CPI
was below forecasts; the September leading economic indicators came in much
stronger than expected.
The Market-Disciplined Investing
Technical
Friday the indices
(DJIA 13343, S&P 1433) busted through the lower boundaries of their short
term uptrends [13462-14293, 1445-1537] and are approaching the 13302/1422
former resistance now support levels. In
addition, the Dow broke below its 50
day moving average while the S&P closed right on its (13351/1433). As I noted the last time the lower boundaries
of the short term uptrends were challenged, I think all three of the
aforementioned supports will serve in tandem, i.e. either they will all break
or they all won’t. In the meantime, our
time and distance discipline is now operative on the short term uptrend
boundaries.
The Averages
remained above the lower boundaries of their intermediate term uptrends (12593-17593,
1327-1925).
Volume on Friday
rose considerably while breadth (advance decline, flow of funds, up/down
volume, and our internal indicator) was negative. Further the charts on the NASDAQ and the
Russell 2000 look really bad. The VIX spiked,
taking it above its 50 day moving average and leaving it in the broad zone
between the upper boundary of its short term downtrend and the lower boundary
of its intermediate term trading range.
GLD was down, finishing
below the interim support level, only slightly above its 50 day moving average
and well above the lower boundaries of its short term uptrend and its
intermediate term trading range. The
break of the interim support level is of concern to me. Since over half of our GLD is a trading
position, our Portfolios will likely Sell one quarter of that Monday morning at
the open and another quarter if GLD breaks its 50 day moving average.
Bottom
line:
(1) the DJIA and S&P are in uptrends, both in the short term [13462-14293,
1445-1537]---though this trend is currently being challenged---and the
intermediate term [12593-17593, 1327-1925],
(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 (13343)
finished this week about 19.0% above Fair Value (11210) while the S&P (1433)
closed 3.2% 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 and may even be straining for a bit higher growth rate. Of course, it was only a couple of weeks ago
that I was reviewing disappointing economic data and cautioning not to get
beared up So it is a bit too soon to be
tip toeing through the tulips. In addition, even if I make the positive
assumption that the economy may actually kick its growth rate up a notch, I
would suggest that it won’t be by much and will barely alter our current long
term outlook---big adjustments long term requires institutional change and we are
nowhere near to that.
And speaking of
institutional change (and I wish that I wasn’t), the election now appears to be
a dead heat. So the chances for ‘a
change in personnel in Washington
So at the
moment, all we can do is wait for developments.
As a final note, in the absence of a ‘change in personnel (policies)’,
our forecast for a sluggish economy growing below its historical secular rate and
a rising risk of inflation will likely remain our forecast for the next five
years.
All that said, I continue to believe
that near term the big Kahuna of risks is the probability of severe economic
dislocations in Europe . Like our own sorry political class, the
eurocrats are focused on insuring the
survival of their bureaucratic infrastructure versus helping their citizens get
out of the horrendous economic circumstances in which they find
themselves.
Greece is teetering on the brink of
economic and social collapse, the Spanish elite are in the midst of a giant
exercise in self delusion while the EU leadership spent the last two days
yakking, drinking whiskey, slapping themselves on the back and telling each
other how smart they are---but doing nothing to correct the financial
deterioration of Mediterranean Europe.
The last act of this play hasn’t
even started yet and it is already a tragedy of such proportion to make Macbeth
look like Saturday Night Live. 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, of course, is our forecast; but my
confidence in it wanes with each passing week.
Even more bothersome, I have no idea about the magnitude of the economic
consequences if Spain Italy
As a result, our Portfolios are
carrying an abnormally high level of cash for a Market that is only about 3%
overvalued (as defined by the S&P). In
addition, I maintain my focus on our Sell versus our Buy Discipline.
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 is not properly addressed and (2) stock 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 want to add to equity positions at
these prices.
The
latest from David Rosenberg (medium/long but a must read):
Our Portfolios
took no actions this week.
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 13343 1433
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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