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 Trading Range (?) 12973-13661
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 Trading Range (?) 1395-1474
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 29%
High
Yield Portfolio 30%
Aggressive
Growth Portfolio 31%
Economics/Politics
The
economy is a modest positive for Your Money. The economic data this week was basically
neutral to positive. It had its pluses
(October personal income and spending, weekly jobless claims, the October ISM
manufacturing index, unit labor costs and October nonfarm payrolls) and
negatives (mortgage and purchase applications, the Dallas Fed manufacturing
index, the Chicago PMI , factory orders and
third quarter productivity); but it also had lots neutrals (the Case Shiller
home price index, weekly retail sales, consumer confidence and September
construction spending).
The important
numbers were October personal income and spending, October ISM manufacturing
index and October nonfarm payroll, all of which were positive---that is what
gives the positive bias to a week in which the numbers were all over the lot. I
continue to be encouraged by this more healthy data flow; but more for what it
doesn’t mean (recession) than what it could mean (a higher rate of economic
growth).
As a result of
these encouraging stats, I am going to add ‘an improving economy’ to the
Closing Bell’s weekly list of pluses---subject to one enormous caveat: the election is upon us; and I don’t have to
tell you how radically different the economy will be managed depending on who
wins (and assuming Romney fulfills his campaign promises). Consequently, our entire
present forecast (not just ‘an improving economy’) is very iffy and could be
subject to change in the next couple of months depending on who wins and how
seriously they pursue their campaign pledges.
At the risk of
repeating myself, my opinion is that a Romney victory, assuming that he fulfills
his campaign promises, would likely lead to a recession by the second half of
2013 (avoid the fiscal cliff, but endure tighter monetary, fiscal policy pain
initially).
An Obama win
would raise the risk of running off the fiscal cliff; but assuming that it was
avoided, then the present accommodative monetary, fiscal policies would
continue (and by definition the slow, sluggish recovery), until higher
inflation and higher interest rates shut the whole process down---we get our
pain later.
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) an improving
economy
(2) our improving energy picture.
The US
(3) the seeming move of the electorate towards embracing fiscal
responsibility. I am hopeful that this more conservative mood
will prevail and that voters have become disillusioned enough with their prior
selection that they choose not to give Him another four years. I would love to see Romney/Ryan prevail and
then follow through with their campaign pledges. Unfortunately, that is a two step process;
and if one or the other doesn’t happen, then we {collectively} will be stuck in
the current economic purgatory that we find ourselves. Equally regrettable, at this late date, the
airwaves are full of contradictory predictions on who is going to win this
election; so it is not even clear that the electorate has indeed embraced
fiscal responsibility.
The negatives:
(1) a vulnerable banking system.
State’s Attorneys’ General continue to file suit against the banks [this
week it was Barclay’s] for various and sundry offenses [see below]. My belief is that the big banks remain too
big to fail, that their willingness to assume risk in their investment
banking/trading operations appears undiminished and that their balance sheets
remain as opaque as ever.
And they are
criminals:
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’. The
good news is that the elections are near; and after it is over, we will get a
better picture as to how the political class plans on addressing this
problem. Right now, I think that we are
more likely to get a compromise with Romney than with Obama---but that could be
my own political prejudice. That said,
whoever wins, logic says that the victor would be a fool to allow us to run off
the cliff; so I have nothing in our forecast that accounts such an occurrence. But the risk exists and its consequences
would have a material impact on our forecast.
A primer on the
fiscal cliff (7 minute video):
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 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.
(3)
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.
‘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. Why will this time be any different?
The
problem with low interest rates (medium):
[b] a blow up in the Middle
East . This area of the
world remains a powder keg---the civil war in Syria Lebanon US Persian Gulf than in the San
Diego Israel Iran US
The risk here
is that any further heightening in tensions or additional conflict could lead
to higher oil prices which, at the least, will act as a hindrance to US
[c] food inflation. With the harvest season almost over, grain
prices remain elevated versus six months ago; although it appears that when all
is said and done, the final crop yields are higher than originally feared. As a result, I am unsure if or how soon
higher prices work their way up the food chain and get reflected in consumer
prices. I will leave this as a risk for
another week or two; but absent a fresh pop in the next price indices reports,
I will likely remove this from our list of risks.
(4)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
Economic and political conditions in Greece Spain
Merrill Lynch:
Greek risk is back (did it ever go away?) (medium):
I have opined frequently
that as long as voters, investors and the financial press 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 and the consequences to the US
Bottom line: the US
That said, all things
are never equal; and right now we are facing an event that has a 100%
probability of occurring but with potentially diametrically opposed
results. That, of course, is the
election; and right now the potential economic outcomes of either candidate
winning are so wide ranging that it is nearly impossible to come up with a
forecast for 2013-2014.
I don’t know who
is going to win on Tuesday; and if Romney wins, I don’t know how firmly he will
stick to his campaign promises. That
means that our current forecast for 2013 is nothing but a wild ass guess. Until we know the victor; until we know his
true agenda, there won’t be a forecast that is worth the paper it is written
on.
So for me, all
that I can do is acknowledge what I don’t know (which is a lot), be objective
about any forthcoming changes in fiscal, monetary and regulatory policy and its
impact on the economy, then make adjustments to our forecast
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; but as I noted, the level of uncertainty
surrounding our assumptions is well above average.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
abysmal; the August Case Shiller home price index rose slightly less than
forecast,
(2)
consumer: weekly retail sales were OK; personal income
was up as anticipated while personal spending was better than expected; weekly
jobless claims dropped more than estimates and October nonfarm payrolls were
well ahead of forecasts; October consumer confidence came in below expectations
but ahead of September’s report,
(3)
industry: the October Dallas Fed manufacturing index
came in slightly worse than forecast as did the October Chicago PMI ;
the October ISM manufacturing index was reported slightly ahead of estimates;
September construction was up as anticipated: September factory orders were
down versus both expectations and August’s reading,
(4)
macroeconomic: third
quarter nonfarm productivity was a bit less than forecast and down from the
second quarter reading; unit labor costs plunged.
The Market-Disciplined Investing
Technical
This week the indices
(DJIA 13093, S&P 1414) re-set their short term trend from up to a trading
range (12973-13661, 1395-1474) but remained within their intermediate term
uptrends (12679-17679, 1338-1934).
Additional
support is provided by the 200 day moving averages (12985.1370); while the 50
day moving averages (13334.1433) will act as an interim resistance point as
well as the 13392,1422 former resistance, turned support, now resistance level.
I wondered out
loud in Friday’s Morning Call whether Thursday’s strong pin action was a dead
cat bounce or the start of something new---we got our answer; and surprisingly,
the retreat occurred on a day that started with a positive nonfarm payroll
number. I don’t think a bad stock day on
a good economic day bodes well for the Market.
So I am sticking to my opinion that the Averages will challenge and
break though the lower boundaries of their new short term trading ranges---but
as I said, that is just my opinion.
Volume on Friday
fell while breadth (advance/decline, flow of funds, up/down volume, and our
internal indicator) was negative. The
VIX spiked off of the lower boundary of a newly formed very short term
uptrend. That is mildly negative and leaves the VIX in the (1) ever narrowing zone
between the upper boundary of its short term downtrend and the lower boundary
of its intermediate term trading range, (2) as well as a much more constricted
developing pennant formation.
GLD fell big
time, pushing down off the upper boundary of a newly formed very short term
downtrend to finish below the interim support level and only slightly above its
50 day moving average. It remains above
its 200 day moving average, the lower boundary of a short term uptrend and the
lower boundary of its intermediate term trading range. However, I think that it will almost surely
test the short term uptrend; and if that is successful, our Portfolios will
likely start re-Buying their trading position.
Bottom
line:
(1) the DJIA and S&P are in
short term trading ranges [12973-13661,
1395-1474] and intermediate term uptrends [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 (13093)
finished this week about 16.3% above Fair Value (11255) while the S&P (1414)
closed 1.4% overvalued (1394). 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 progress at a rate perhaps a little north of our current
forecast. To be clear, this is not ‘lift
off’ speed but it is enough to move the immediate threat of recession to the
back burner. As I noted above, we have too many institutionalized problems that
need fixing before a return to a historical secular growth path is possible.
As far as a
‘change in personnel in Washington
Whatever happens in Washington Europe
as the principal near term threat to our forecast. Not that the EU will fall apart in the next
two months; but if it doesn’t, it won’t be because the eurocrats did anything
meaningful to prevent it.
Indeed, both Greece Spain Europe will be allowed to
continue to ‘muddle through’.
Not that I have
been betting heavily on an EU implosion.
As you know, I have maintained ‘muddle through’ as our default position all
along even as it has seemingly becomes less likely. My only excuse for not altering our
forecast/strategy, and to be sure, it is not a good one, is that I get nervous
when the market acts like it knows something that I don’t know (like everything
will work out fine for the euros). In my defense, our Portfolios do have a
roughly 30% cash position at this moment and that should help preserve
principal if the feces hit the windmills in Spain
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 [a] the fear of fighting
a far too easy, money printing Fed and [b] the sort of hopeless resignation
that stocks are at this moment the least worse investment---not the two best
reasons that I can think of for an up Market.
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.
Since
our last Closing Bell, our Portfolios Sold their trading position in GLD.
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 11/30/12 11255 1394
Close this week 13343 1433
Over Valuation vs. 11/30 Close
5% overvalued 11817 1463
10%
overvalued 12380 1533
15%
overvalued 12943 1603
20%overvalued 13506 1672
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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