The Closing Bell
As you know, next week is Thanksgiving. As usual I will be doing most
of the cooking. Plus I have to do a quick turnaround to San Francisco Bell
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
+1.0-
+2.0%
Inflation
(revised): 2.5-3.5 %
Growth
in Corporate Profits: 5-10%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 2.5-3.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Down Trend (?) 12625-13109
Intermediate Up Trend
12765-17765
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Down Trend (?) 1365-1415
Intermediate
Term Up Trend 1347-1943
Long
Term Trading Range
766-1575
Very
LT Up Trend 651-2007
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 29%
High
Yield Portfolio 30%
Aggressive
Growth Portfolio 31%
Economics/Politics
The
economy is a modest positive for Your Money. Virtually all of this week’s economic data were impacted by Sandy
‘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.’
As you know, this
outlook comes with one caveat; and it centers on the how the impending fiscal
cliff is resolved. To be sure, I think
that options (1) and (2) below are low probabilities; but they exist and have
to be accounted for:
(1)
the grand bargain:
The post election happy talk [Friday’s love fest notwithstanding] is now
fading as both sides have started laying down markers. What disturbs me is that all the verbiage is
about the size, if any, of tax cuts.
Nobody is talking about reductions in spending---which are far more
important to reducing the deficit than tax increases. Hopefully, we will get there but I fear that
Obama’s current strategy of wearing down the republicans defending the ‘taxes
on the rich’ is working all to well.
That tells me that the odds of a grand bargain are rapidly slipping from
slim to none.
(2)
we run off the cliff: while Obama has yet to say it,
many of His minions have: ‘there was an election and elections have
consequences’. That, of course, was His
post 2008 attitude and we know how much compromise there was then. The more often this argument is thrown at the
republicans, the more likely they will become intransigent in their own
willingness to compromise---suggesting that the probabilities of this scenario
occurring are rising. Were this to
happen ‘our 2013 outlook [1-2% real GDP growth] would fly out the window and
would likely move forward the ultimate day of reckoning [which I define as the
day the world refuses to accept any more US debt without a significantly higher
price tag---fiscal and monetary austerity are thus imposed from the outside and
the US gets a nasty and extended recession---see Europe],’
(3) a not-so-grand compromise: as I have previously opined, if our political
class sticks to its recent modus operandi, they will come up with some half
assed solution that doesn’t fix our broken tax system but does raise taxes on
the rich [we just don’t know how that will be defined], that keeps much of the
purposeless social spending in place to feed the growing new class of
dependents, that does little to solve
our deficit/debt problem and to the extent that it does anything, does in the
out years [7 or 8 years from now] and last but certainly not least, this
solution will likely only be reached at the eleventh hour after the politicians
have scared the holy hell out of the electorate/investors.
I rate this as the most likely scenario
primarily because it is the most typical.
The good news is that aside from paralyzing the nation for a week or two,
it would not change our sluggish but still positive growth outlook. On the other hand, it leaves us to face our
day of reckoning somewhere out there in the future.
I want to be
sure that I am being absolutely clear about something. Most of the ongoing public debate is about
whether or not the US US
It is more than just the fiscal cliff
(medium and a must read):
Update on big four economic indicators as well as a
study on how they performed after Katrina (medium and very enlightening):
The pluses:
(1) an improving economy. The ability
of American business to improve its operations and grow is truly a wondrous
thing. It has demonstrated this unique
capacity in the last decade in spite of a far too intrusive government that
over taxes, over spends and over regulates.
Undoubtedly, it could continue to do so, if status quo could be
sustained.
(2) our improving energy picture.
The US
The
negatives:
(1)
a vulnerable banking system. With a friendly White House and Fed, our
banking class is now able to continue their free wheeling management style with
the sure knowledge that they will be bailed out of any missteps and not be held
to account for those actions.
This week the
powers that be made a great show out of condemning Jon Corzine for his
mismanagement of MF Global; but the last I checked, he was still walking around
a free man and with his bank account intact.
Sticks and stones....................
‘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.’
The banks are still too big
to fail (medium):
(2) the ‘fiscal
cliff’. [see above].
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
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 if 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 and/or
manage the fiscal cliff.
(2)
rising inflation:
[a] the potential negative impact of central bank money printing. The central banks of the major global
economic powers are now ‘all in’ for
monetary easing; meaning that the world is awash in liquidity. Furthermore, with an Obama win, Ben’s job is
safe; so he is under no pressure to stop the presses.
Indeed, this
week in the released minutes of the most recent FOMC meeting, it was clear that
[a] QEIII will probably go on for some time and [b] the Board can’t even agree
on the trigger that would persuade it to halt monetary easing and/or begin
shrinking the money supply.
‘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 {three
times} 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 (the latest rumored guideline is 7.25% }. 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. [see above FOMC comment]
[b] a blow up in the Middle
East . This week this area
of the world went from powder keg to explosion; and this was just the opening
scene. Who knows to what level the
violence will reach? However,
irrespective of the extent of hostilities, oil prices are rising and will
likely continue to do so till calmer heads prevail.
The risk here
is that these higher oil prices could last long enough to begin hindering US
Interview
with Israeli ambassador (short/medium):
Petraeus’
congressional testimony (short):
[c] food inflation. Both PPI and CPI
were reported this week and the results were quite tame. Further, the winter wheat crop appears to be
a good shape. I am removing food
inflation as a risk.
(3)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
Economic and political conditions continue to deteriorate throughout Europe ---this
week, the eurocrats couldn’t even agree on a Greek solution while speaking at
the same news conference. That is not a
good sign that a fix is near.
The question
is with our fiscal cliff duking it out with increasing violence in the Middle
East for the lead headline, to what extent are stocks starting to price in
something other than a ‘muddle through’ scenario in Europe? Given the
increasingly apparent dysfunctionality of EU bureaucrats, I am going to assume
some of the downside risk of an unraveling of the EU is being discounted,
though I am convinced that it is not sufficiently so.
And this bit of wisdom from Kyle
Bass (short):
Bottom line: the US
This assumes
some clumsy, derisory solution to the fiscal cliff which won’t solve much but
will keep the economy from plunging off the cliff. So the risk of a new recession should fade
when and if some budget compromise is agreed upon; unless, of course, Europe
or the Middle East blows up.
Unfortunately
neither Europe nor the Middle East
are risks that could happen--- like the fiscal cliff---they are
happening. The only question is how much
worse will they get? I am less worried
about the magnitude of the likely consequences in the Middle East . Europe , though, is an
economic basket case that could turn into an outright disaster if the eurocrats
can’t figure out a solution other than to hope and pray. The risk is that
inertia and ineptness win out, Spain defaults, Italy goes on the blocks, the
recession turns to depression and the financial system implodes sending shock
waves though the global banking system.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications bounced
back from the rough Sandy impacted numbers of the last
week,
(2)
consumer: weekly retail sales rebounded from the Sandy
induced decline of the prior week while October retail sales were down as
Sandy’s influence moves from weekly to monthly data; weekly jobless claims soared but it too
reflected Sandy,
(3)
industry: September business inventories and sales were
very strong; both the New York and Philadelphia Feds’ manufacturing indices
came in below estimates as did October industrial production---all due
primarily to Sandy,
(4)
macroeconomic: both October PPI deadline and core
numbers were down versus expectations of an increase, while both October CPI
stats were in line with forecasts.
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 12580, S&P 1359) rebounded but still closed below the lower
boundaries of their newly re-set short term downtrends (12625-13107,
1365-1415). In fact, because the
Averages have been so far below those lower boundaries for a number of days,
they have developed new very short term downtrends (12333-12735,
1317-1359).
Notice a couple
of things: (1) the S&P is right on the upper boundary of its new very short
term downtrend. A failure to trade above this weak resistance level would be a
negative for stocks. (2) it would take
another up day or two like Friday just to get the Averages back to the lower
boundaries of the short term downtrends. In other words, a couple more days of
positive performance will do nothing to alter the Market’s negative short term
bias.
The only bright
spot in this picture is that the S&P managed to rally back above the lower
boundary of its intermediate term uptrend (1347-1943); although the Dow remains
below its comparable level (12765-17765) for the third day in a row. That leaves the Averages out of sync. It offers the hope that the DJIA will follow
the S&P back to the upside; although at this point, I wouldn’t count on it.
Volume on Friday
was up---not unusual for an options expiration day. Breadth improved considerably more than I
would have expected. The VIX plunged,
closing once again below the lower boundary of its very short term uptrend but
remaining below the upper boundary of its short term downtrend and above the
lower boundary of its intermediate term trading range.
GLD sold off
fractionally, finishing below its 50 day moving average but above the lower
boundaries of its short term uptrend and its intermediate term trading range.
Bottom
line:
(1)
the DJIA and S&P [a] have developed new very short
term downtrends {12333-12725, 1317-1359} and [b] are below the lower boundaries
of their short term downtrends {12625-13107, 1365-1415}. The Dow closed below the lower boundary of
its intermediate term uptrend [12765-17765] for the third day; while the
S&P finished above its comparable level [1347-1943],
(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 (12580)
finished this week about 11.7% above Fair Value (11255) while the S&P (1359)
closed 2.5% undervalued (1394). Incorporated
in that ‘Fair Value’ judgment is some sort of compromise on the fiscal cliff, a
‘muddle through’ scenario in Europe and a lowering of
the long term secular growth rate of the economy.
The above
assumes that the economy continues to progress, although it was impossible to
tell in a week of data heavily impacted by Sandy
As to the compromise on the fiscal cliff, I
have made it clear that I think that it will be the bare minimum needed to get
a bill signed. No grand bargain nor
anything that will alter the ‘too much government spending, taxes and
regulations’ scenario---just enough to keep the economy from dropping off the
cliff.
I say this with
full knowledge of the happy talk that filled the airwaves Friday afternoon as
congressional leaders made nicey-nice in front of the cameras after their
meeting with Obama. Regrettably, nobody
said anything about a changed position; they all simply said that they
recognized the problem---which again nobody bothered to define but presumably
they meant too much spending and not enough revenue.
Nevertheless,
suddenly investors got all hyped up that these guys have some new understanding
of the problem. Please. There is absolutely nothing special about these
clowns recognizing the problem. For gosh
sakes, they recognized it fifteen months ago when they came up with this whole
fiscal cliff idea in the first place. They
just didn’t want to deal with it then because they were all angling for the
elections in hopes that the balance of power in Washington
So nothing has
changed---not the problem and not the problem solvers. The only thing to get jiggy about is that our
elected representatives aren’t so stupid as to run us off the cliff. Unfortunately, that doesn’t mean that they
are smart enough to come up with a
compromise that will do the economy any good. So to repeat myself, it is highly likely, in
my opinion, that a compromise is reached.
It just won’t change anything---not the economic outlook, not any
assumptions in our Valuation Model. The
optimists on a grand bargain may be proven correct. Color me skeptical.
In addition, it
doesn’t mean that negotiations won’t come down to the eleventh hour, 59th
minute and 59th second. This
is likely what will give investors heartburn---the prospect of watching these
morons endlessly quibble and posture for the cameras until they have one foot
off the cliff and then save the economy with some numb nut agreement that my
six year old grandson could have done three months ago.
Moving on to something important, I
have to hold my nose when I suggest that Europe will
‘muddle through’; because there is no evidence to date that the EU political
class is any better at dealing with difficult problems than our own. Indeed, the only reason for making such a
forecast is that so far it has worked.
In other words, the assumption is that despite one bone headed move
after another, the eurocrats will somehow snatch victory from the jaws of
defeat at the eleventh hour.
I recognize the
flimsiness of such an assertion.
However, while I may believe that the odds of ‘muddling through’ are
shrinking by the day and may currently be no better than 50/50, I don’t know
how to quantify not ‘muddling through’.
I do believe that the consequences will be severe: depressing economic
activity (which I can quantify) and another financial crisis (which I can’t;
simply because we have no idea how much of the notional value of current CDS’s held
in the banks will become exposed when those banks start going under).
My solution to
this dilemma, as you know, is to carry an above average cash position as
insurance and to insist on lower stock prices to reflect the risk.
My investment conclusion: if there is any good news in the above
discussion, it is that risks listed above are starting to be reflected in stock
prices. That means that at some point
our Portfolios need to begin taking advantage of the opportunities on their Buy
Lists. That point is upon us; and it is
generally when I increase my dependence on technical analysis. So the first thing, I want to see is how the
Averages resolve their current challenge of the lower boundaries of their intermediate
term uptrends. If prices hold, our
Portfolios will likely put some money to work.
If not, then they will do nothing at least until the indices re-set to
an intermediate term trading range.
Current revenue
‘beat’ rates (short):
Third quarter earnings were not any
better (short):
Last
week, our Portfolios took no action.
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.
(3)
defense is still important.
DJIA S&P
Current 2012 Year End Fair Value*
11300 1400
Fair Value as of 11/30/12 11255 1394
Close this week 12580 1359
Over Valuation vs. 11/30 Close
5% overvalued 11817 1463
10%
overvalued 12380 1533
15%
overvalued 12943
1603
Under Valuation vs.11/30 Close
5%
undervalued 10692 1324
10%undervalued 10129 1254 15%undervalued 9566 1184
* 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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