The Closing 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 Trading Range 12460-13302
Intermediate Up Trend
12907-17907
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 Trading Range 1343-1424
Intermediate
Term Up Trend 1363-1958
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. The economic data this week was weighted on
the plus side: positives---weekly mortgage purchase applications, November auto
sales; weekly jobless claims, November nonfarm payrolls, November PMI ,
the November ISM nonmanufacturing index, October construction spending, October
factory orders and the third quarter productivity and unit labor cost numbers;
negatives---the November ISM manufacturing index and December consumer
sentiment; neutral---weekly retail sales, weekly mortgage purchase applications
and the ADP private payroll report.
Some of these
numbers still contain Sandy related information;
however, in total, they are a reasonably accurate look at the economy. More important, they were solidly positive
after a month of either slightly negative or Sandy masked data. That suggests that the economy is tracking
with 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.’
Update on the
big four economic indicators (medium):
The pluses:
(1) slightly stronger data than currently in our outlook. This factor has been clouded of late primarily
by the Sandy impacted stats; but this week’s numbers
seem to be supporting this notion. Of
course, that means nothing if the ‘fiscal cliff’ isn’t resolved satisfactorily
or if Europe implodes.
Those issues aside [see below] I think that American business has done a
marvelous job recovering from the financial crisis in the face of a far too
intrusive government that over taxes, over spends and over regulates.
(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.
Several things
occurred this week that bear mentioning [a] Citigroup laid off 12,000-15,000
employees---not a sign that this institution has achieved financial health, [b]
Deutsche Bank reported that it had not disclosed $12 billion in losses on its
balance sheet during the financial crisis. While a German bank, it still reveals
the mentality of global big bank management---they are all a bunch liars,
thieves and rule breakers.
‘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 issue is,
of course, center stage at the moment.
As you know, there are basically three alternative outcomes: (1) the
right one, i.e. a grand bargain that reforms the tax code as well as the
entitlement system, (2) the wrong one, i.e. we go off the cliff, and (3) the
half assed one, i.e. an agreement but no real reform and not before investors
soil their trousers. You also know my
opinion as to which alternative we will get---door number 3.
The good news
is that this solution defines our long term forecast in the same terms as our
12-18 month outlook---so it saves me a lot of work.
It is
important to note that the deadline for coming up with a fix is not 12/31 as
the talking heads keep reminding us---it is 12/17-18. Obama leaves for Hawaii
So for all
intents and purposes, a compromise has to be reached by the time that next
week’s Closing Bell is published. The
odds of this happening seem a bit long to me; especially since Congress awarded
itself a long weekend, this weekend.
Certainly,
miracles do occur; but at the moment, it seems to me that door #3 is a
lock. To be clear, I believe that an
agreement will be reached; it just won’t happen the easy way.
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. As you know, the Fed along with the central
banks of the major global economic powers are now ‘all in’ for monetary easing. Nothing occurred this week to suggest that
any of these guys are backing off their full Monte policies. Indeed, it was rumored that the Fed would
announce QEIV after the FOMC meeting next week.
‘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 {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 . Well, we had one
blowup {Gaza Syria
While the
relative stability of oil prices in the face of the above is encouraging, I
don’t think that it 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 in Greece
In addition,
Italian PM Monti’s economic [austerity] policies suffered through but defeated
a ‘no confidence’ vote. Analysts believe
that this won’t be the last such challenge; and were Monti to lose, he could be
replaced by someone far less market friendly.
Finally, the
economic data out of Europe reflected further
deterioration; and on Friday, Draghi presented a far from optimistic assessment
of EU economic activity over the next 12 months.
Net, net,
economic and political conditions continue to worsen throughout Europe ---which
brings them and us ever closer to a disruptive event.
Counterpoint
(medium):
As I noted
last week: ‘While the question on
investors’ minds at the moment seems to be ‘how likely is it that the US Europe implodes. First because the fiscal cliff
is not likely to occur and secondly because we know exactly how much the US
Bottom line: the US
The risk of
multiple European sovereign/bank insolvencies is the turd in the punchbowl of
our forecast primarily because (1) the probability of its occurrence rises
daily as the eurocrats insist on avoiding a real solution and (2) as I note
repeatedly, I am not smart enough to quantify the downside which I intuitively
believe to be rather large. We may get
lucky and Europe muddles through; but I fear something
far worse.
A review of the
global economy (medium/long):
This week’s
data:
(1)
housing: weekly mortgage and purchase applications rose
though purchase applications’ increase
was anemic,
(2)
consumer: weekly retail sales reflected seasonal
factors on their weekly comparisons but were positive on a year over year basis; November auto sales
were strong; weekly jobless claims fell
while the ADP private employment report
showed weak growth; the November nonfarm payrolls report was very positive
[though there was some problems with the make up of this number---see below]; and
December consumer sentiment plunged to 74.5 versus estimates of 83.0,
http://www.zerohedge.com/news/2012-12-07/chart-day-jobs-additions-age-group-reveals-scariest-picture
(3)
industry: November
purchasing managers index came in above expectations; while the November ISM nonmanufacturing index
improved, the manufacturing index was a big disappointment; October construction spending
was a blowout number as were October factory orders,
(4)
macroeconomic: both third quarter nonfarm productivity
and unit labor costs were better than estimates.
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 13155, S&P 1418) finished on an up note and within their (1) short
term trading ranges [12460-13302, 1343-1424] and (2) their intermediate term
uptrends [12907-17907, 1363-1958].
For the second
week, the S&P also closed within a very tight trading range (1395-1424). As fate would have it, its 50 day moving
average is also within that range (1416)---so there is a lot technical
congestion at current levels.
Looking for
signs of how this bottleneck might be resolved, I offer three indications:
(1)
on Friday, the S&P [and the Dow] closed above that
50 day moving average. Our time and
distance discipline is now operative for this trend line to confirm this
break. The time element is two to three
days,
(2)
I performed two studies on our own internal indicator
with the following results:
[a] of 157
stocks in our Universe, 104 are above their 50 day moving average, 46 are not
and 7 are too close to call,
[b] of 157
stocks in our Universe, 82 are above the
comparable S&P 1424 level, 60 are not and 15 are too close to call.
All
three of these signals suggest an upside resolution out of the 1395-1424
trading range. Were that to occur, the
next resistance level for the S&P is 1474.
Volume on Friday
was flat; breadth was up. The VIX fell
below its 50 day moving average (a plus for stocks) and closed in the narrowing
zone between the upper boundary of its short term downtrend and the lower
boundary of its intermediate term trading range.
GLD was up fractionally
and remains below its 50 day moving average but above the lower boundaries of
its short term uptrend and intermediate term trading range. A confirmed break
below the former will likely prompt sale of a portion of our Portfolios’
investment position.
Bottom
line:
(1)
the DJIA and S&P are in [a] short term trading
ranges {12460-13302, 1343-1424} and [b] intermediate term uptrends {12907-17907,
1363-1958},
(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 (13155)
finished this week about 16.4% above Fair Value (11300) while the S&P (1418)
closed 1.3% 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.
Pursuant to item
(2) above, it appears that a resolution will not be reached before year end
which I had thought would produce some heartburn among investors. At the moment, they seem to be happy as clams
with the thought that the exact timing of any agreement is not that important
and that any drama in the negotiating process will just be part of the
show.
That may prove
to be the correct scenario; and if it is, then I will clearly have been wrong. That said, I am still unconvinced. Indeed, I believe that there is a strong
argument to be made that a compromise will be reached only if there is panic in
the Markets that in turn forces the politicians hands. In the end, the only relevance to this
difference in perspective is whether any
hard sell off on fears of no compromise creates a buying opportunity.
More concerning to me with respect to
both our Economic and Valuation Models is whether or not Europe
can manage to ‘muddle through’. This
week, the economic news showed continuing deterioration across most of the
continent but especially in the southern half. Ominously, Germany Italy
For whatever
reason, investors also appear no more
concerned about economic turmoil in Europe than they are
about it here. As long as they do and
Markets stay calm, the eurocrats will be able to kick the can down the road and
‘muddle through’ will remain the operative scenario. And as you know, that is the current
assumption in our Models.
‘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). Witness
the Deutsche bank story this week in which it admitted that it had hidden $12
billion in derivative losses during the 2008/2009 financial crisis.
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: with stocks (as defined by the S&P)
slightly above Fair Value, I am not jumping up and down to put our Portfolios’
cash to work. This judgment is made all
the more so by the undetermined risks associated with the EU crisis. However, if those risks begin to be reflected
in stock prices, our Portfolios will become Buyers.
The pricing of uncertainty (medium):
Last
week, our Portfolios unwound the last of poor trading purchase of GLD the prior week, selling the remaining shares
of that trading position.
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 12/31/12 11300 1400
Close this week 13155 1418
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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