The Closing Bell
The Christmas holiday is here and I am once again going to take a
break. I will be back on 1/2/13 but the notes that week will be
abbreviated. Oklahoma Texas 1/4/13 which will involve incoming friends from
out of town as well as pre and post game festivities. I will be back full time of 1/7/13 . In
the meantime, I, as usual, will be keeping abreast of the Market; and if action
is needed in our Portfolios, I will be in touch via Subscriber Alerts. Have a very happy holiday season.
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 Trading Range 12460-13302
Intermediate Up Trend
13009-18009
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 Uptrend 1426-1476
Intermediate
Term Up Trend 1373-1968
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 33%
High
Yield Portfolio 34%
Aggressive
Growth Portfolio 35%
Economics/Politics
The
economy is a modest positive for Your Money. This week’s economic data was basically mixed:
positives---existing home sales, personal income, durable goods orders, and the
Philly Fed manufacturing and Chicago National Activity indices; negatives---mortgage
and purchase applications, housing starts, jobless claims, consumer sentiment
and the New York Fed manufacturing index; neutral---weekly retail sales, personal
spending, third quarter GDP and the November
leading economic indicators.
These stats are
nicely supportive of 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.’
And (short):
Update on the
big four indicators:
The
pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy.
As you know, I added this factor last week but with the caveat that
there is disagreement among the experts about the extent of the progress. All
things considered, I think that there is sufficient evidence to support the
notion, even though we got no statistical collaboration this week.
The
negatives:
(1) a vulnerable banking system.
The Libor price fixing scandal continues to widen with UBS
getting tagged with a $1.5 billion fine.
Once again this didn’t involve a US institution; but it is still illustrative
of several points that I have been making: [a] the continuing lack of financial
controls at major global institutions and [b] the negative consequences of an
easy money, zero interest rate policy spawning the chase for performance by investors
in particular those who are gambling with someone else’s money.
And (short):
‘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) the ‘fiscal cliff’. This week, the republicans abandoned the talks
on a compromise, tried to pass Boehner’s Plan B, failed and went home for
Christmas. This most likely means no compromise before 1/1/13 .
On the other
hand, we already know what Obama wants and He clearly holds all the cards right
now. The Tea Party republicans now appear
to have two choices: (1) play hard ball, refuse to compromise, push the economy
over the cliff and suffer the consequences, i.e. lose control of the House in
2014 or (2) take Ann Coulter’s advice, vote present on the Obama plan and make
sure the electorate knows that He owns this plan.
#2 above is roughly
the alternative built into our Model [some tax increases, few spending cuts, and
nothing to alter the longer term sub par growth rate of the economy]. However, the odds of #1 above occurring have
gone up; and were it to happen, the economic outlook for 2013 would turn
decidedly negative.
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.
(3)
rising inflation:
[a] the potential negative impact of central bank money printing. In last week’s Closing Bell, I posed the
question of how soon would the rest of global central bankers follow the Fed’s
attempt to break the intergalactic speed record for money printing. This week, Japan
‘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 {QEIV}, 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 {four 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}. 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.
[b] a blow up in the Middle East . There was not much news out of the Middle
East this week, save that Russia was sending two naval squadrons to the area. However, I don’t think that this lack of news
mitigates the risk that a larger scale conflict {US invades Syria, Israel bombs
Iran} brings impairment to either the production and/or the transportation of
crude oil out of the Middle East long enough to begin hindering US {and global}
economic growth and ultimately pushes the economy into recession and/or adds
fuel to inflationary impulses
(4) finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
This week was generally quiet though there was some improvement in the
economic data suggesting that conditions may have stopped getting worse (‘may’
being the operative word). On the other
hand, the political situation in Italy Italy
All in all,
this news does little to alter my opinion or assuage my concerns; although the
longer investors are willing to believe that the EU can ‘muddle through’, the
better chance there is that the eurozone economy can improve and allow the
eurocrats to sustain their pipe dream. It
may happen; but if it doesn’t (and I still think that the odds are that it
won’t), I can’t quantify the downside and that’s a problem.
Bottom line: amazing as it is, the US
Uncle Ben isn’t
helping matters either. In my opinion sooner
or later, QEIV will almost certainly lead to higher inflation. That said, the fall in the price of gold this
week at the very least raises doubts as to the timing of any surge in price
levels. For the moment, I am sticking
with my forecast that the longer the Fed pumps money into the system and the
more bloated its balance sheet becomes, the harder it will be to get the timing
and magnitude of monetary tightening correct.
However, as I noted in Friday’s Morning Call that assumption is now
under review.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies, though, as I said
above, recent data suggest Europe may be through the
worst of its current slowdown. Coupled
with investors’ current overly faithful confidence that the eurocrats will
somehow hold the EU together, it would seem that our ‘muddle through’ scenario
has a bit of a better chance of succeeding than I have been reckoning of
late. That doesn’t mean that the EU will
‘muddle through’; and if it doesn’t, I still have no clue how to assess the
consequences of a crisis though I believe them to be significant.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications fell
sharply; November housing starts declined more than anticipated while existing
home sales came in above forecasts,
(2)
consumer: weekly retail sales were mixed; weekly
jobless rose more than expected; November personal income was above estimates
while personal spending was in line; December consumer sentiment came in lower
than anticipated,
(3)
industry: November
durable goods orders were strong; the December NY Fed manufacturing index was
very disappointing while both the Philly Fed manufacturing and the Chicago
National Activity indices were above expectations,
(4)
macroeconomic: third quarter GDP
was revised upward; however most of the change was due to inventory build; the
November leading economic indicators fell but in line forecasts.
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 13190, S&P 1430) had a rough day.
While the Dow closed back below the upper boundary of its short term
trading range (12460-13392), the S&P did not return to a comparable level
(1424) and remained within its newly re-set short term uptrend
(1426-1476). Both continue to trade
within their intermediate term uptrends (13009-18009, 1372-1968).
Thursday’s DJIA break
above the upper boundary of its short term trading range has once again been rejected. So any move back above that boundary will
simply re-start the clock on the time element of our discipline.
The Dow is also now
back out of sync with the S&P which has broken out of its short term
trading range and re-set to an uptrend. This
pin action suggests that stocks are in a battleground zone between the bulls
and bears---which means that our job is to stay patient until the Market works
itself out directionally.
Volume on Friday
soared (but it was option expiration); breadth was down. The VIX was up a little; however, it couldn’t
close above the upper boundary of its short term downtrend which I think a
positive for equities.
GLD was up
fractionally, but remains in a newly re-set short term downtrend. However, it continues to trade above the
lower boundary of its intermediate term trading range.
Bottom
line:
(1)
the DJIA is in a short term trading ranges [12460-13302],
while the S&P has re-set to a short term uptrend [1426-1476]. Both remain within their intermediate term
uptrends {12948-17948, 1368-1963},
(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 (13190)
finished this week about 16.7% above Fair Value (11300) while the S&P (1430)
closed 2.1% overvalued (1400). 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.
‘As you
know, our assumption on the fiscal cliff is that (1) there is no ‘grand
bargain’, (2) a compromise will be reached; and if not by year end then by
early 2013 and provisions will be retroactive and (3) the agreement itself will
do nothing to help the economy. That is,
taxes will be raised and spending will be barely cut, if at all. This is exactly the scenario built into our
Models; so nothing will change in terms of equity valuation unless we get a
grand bargain or our political class allows the cliff to happen.’
This week our
political elite took two steps backward on the fiscal cliff---Boehner tried
Plan B and failed. There was nothing
left to do but go home for the Holidays.
As you know, I still think that we will get some half assed excuse for a
compromise. It may come later than many
wished; but probably not so late that more damage is inflicted on the economy.
The immediate Market
question is, will investors retain their Pollyanna attitude toward the cliff
following the demise of Plan B? Friday’s
pin action would appear to at least partially answer that question in the
negative. However, stocks (as defined by
the S&P) are still overvalued (at least as defined by our Valuation
Model). So I don’t think that Friday’s decline
necessarily presages investors giving up hope and panicking. That is not to say that they won’t; just that
they haven’t yet.
I am still of
the opinion that there is a reasonable argument to be made that until investors
do panic and thump the Market, the politicians will continue to dick around and
avoid having to make any firm decisions on taxes and spending.
Gold’s
performance this week has given me reason to question the inflation assumptions
in our Economic Model and the size of the GLD holding in our Portfolios. Indeed, as you know, having Sold all of our
trading position as couple of weeks ago, our Portfolios Sold one half of their
investment position Thursday. That
doesn’t mean that I am changing our outlook.
It does mean that I am reviewing it and in the meantime want to preserve
our profit in this holding.
The bad news
is that I still 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 creating 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 investment conclusion: while no economic good will likely come from a
resolution of the fiscal cliff, the Market impact could be significant if these
morons continue to fiddle.
No economic good will likely come from
QEIV. Rather as I have noted, it will
simply continue to distort the math of investment returns, add to future
inflationary pressures, rob savers and line the bankers’ pockets. Sooner or later, I believe this will
negatively affect the rate at which future earnings are discounted.
The more significant issue is the
fragility of both the EU and the US
The latest from David Rosenberg
(medium):
Last
week, our Portfolios Sold one half of their investment 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 [which is now under review]. 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 12/31/12 11300 1400
Close this week 13190 1430
Over Valuation vs. 12/31 Close
5% overvalued 11865 1470
10%
overvalued 12430 1540
15%
overvalued 12995 1610
20%
overvalued 13560 1680
Under Valuation vs.12/31 Close
5%
undervalued 10735 1330
10%undervalued 10170 1260 15%undervalued 9605 1190
* 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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