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
12857-17857
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 1357-1952
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. There was quite a bit of data this week; and I
would characterize it as mixed/neutral: positives---weekly mortgage purchase
applications, the latest Case Shiller home price index, November consumer
confidence, October durable goods orders (ex transportation), the Richmond
Fed’s manufacturing index, November Chicago PMI
and revised third quarter GDP ;
negatives---weekly mortgage applications, October personal income and spending,
the Chicago Fed’s national activity index, the Dallas Fed’s manufacturing index
and revised September new home sales; neutral---weekly retail sales, October
durable goods orders, weekly jobless claims and the latest Fed Beige Book.
Some of these
numbers contain Sandy related information; some did
not. So in aggregate, (1) they don’t
provide an exact picture of the economy, (2) but they are not distorted enough to prevent us
from concluding that they continue to reflect a struggling economy. In other words, they fit nicely with our
current outlook:
‘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) an improving economy. This
factor is, of course, dependent on how the ‘fiscal cliff’ gets resolved and
whether or not Europe implodes. That said, American business is doing the
best it can to overcome a far too intrusive government that over taxes, over
spends and over regulates. That doesn’t mean that the economy will return to its
historical secular growth rate; but it does mean that industry will continue to
innovate to at least partially compensate for the burden that is the US
(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.
The latest
problem to appear on the horizon is the impending student loan crisis---yet
another example of the government encouraging poor lending practices with the
implied prospect of bailing out the financial system should things go
wrong. Well, things are starting to go
wrong; witness the skyrocketing delinquency rates among this class of
loans. Sooner or later this is going to
cause massive heartburn for someone; and if history repeats itself, it will be
the US
‘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.
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.
The myth of austerity (medium and must
read):
(2)
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. This week some declared themselves more than ‘all
in’: {i} the Bank of Japan proposed its version of QEXII and {ii} with Uncle
Ben’s job now safe, he let the markets know that he would likely up his commitment
to the paper and ink industries and inject even more money into the
system---what the hell, you only live once, right?
‘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 (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.
[b] a blow up in the Middle
East . Well, we had a blowup
but it had a limited impact on oil prices---though gasoline prices are
higher. Of course, the Palestinian/Israeli
skirmish is a sideshow to the main event.
So while I am encouraged that the short Gaza Israel Iran
The risk here
is that war 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, the eurocrats threw more spaghetti on the wall to see
if anything would stick. So far the
answer is nein. In Spain, there was [a] another regional vote for secession and
[b] a new plan to help shore up the banks---which had it good points but also
some bad. Net, net, economic and
political conditions continue to deteriorate throughout Europe---which brings
them and us ever closer to a disruptive event.
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 continues to weigh heavily on our
forecast. For one, the probability of
its occurrence rises daily as the eurocrats insist on avoiding a real solution. And secondly 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.
This week’s
data:
(1)
housing: weekly mortgage applications fell but purchase
applications rose nicely; October new home sales fell slightly but the
September number was revised down big; the September Case Shiller home price
index was up,
(2)
consumer: weekly retail sales continued their rebound helped
by the timing of Thanksgiving and Black Friday; November retail sales were a
meager advance over October but they were impacted by Sandy; both October
personal income and spending were disappointing but also reflected the
influence of Sandy; November consumer confidence was above expectations; weekly
jobless claims dropped though less than anticipated,
(3)
industry: the
Chicago October national activity index and the Dallas Fed manufacturing index
were sub par while the November Richmond Fed manufacturing index was well above
estimates; the November Chicago PMI
was ahead of forecasts; October durable goods orders were so so, but ex
transportation, the number was good,
(4)
macroeconomic: the latest Fed Beige Book was generally
up beat; revised third quarter GDP was up
but that was anticipated.
Revisions to economic data (short
and must read):
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 13025, S&P 1416) drifted higher.
As a result, they finished for the third day above the upper boundaries
of their short term downtrends, thereby confirming the break of those
trends. They will now re-set to short
term trading ranges, the lower boundaries of which are 12460/1343. The initial candidates for the upper boundaries
are the 50 day moving averages (13178/1419) and/or the 13302/1422 former support
now resistance levels.
They remain well
within the boundaries of their intermediate term uptrends (12857-17857,
1357-1952). Having successfully tested
the lower boundaries of those intermediate term uptrends, our portfolios will
likely put money to work on a second challenge.
Volume on Friday
was up; breadth was mixed. The VIX rallied
but remains below its 50 day moving average and the upper boundary of its short
term downtrend. It trades above the
lower boundary of its intermediate term trading range. (neutral)
GLD sold off
fractionally; and remains below its 50 day moving average. It is near a support level (164) and above a
very short term uptrend. However, if it trades
below the 164 level, our Portfolios will Sell the remaining shares of Tuesday’s
trading Buy. GLD is still above the
lower boundaries of its short term uptrend and intermediate term trading range.
Bottom
line:
(1)
the DJIA and S&P [a] are re-setting to short term
trading ranges and [b] continue to trade within their intermediate term
uptrends {12857-17857, 1357-1952},
(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 (13025)
finished this week about 15.2% above Fair Value (11300) while the S&P (1416)
closed 1.1% 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.
The ‘lowering of
the long term secular growth rate of the economy’ follows from the assessment
that the fiscal cliff agreement will be non-optimal, that is, we do not get the
‘grand bargain’ of tax and entitlement reform on the fiscal cliff---to which I
give a very high probability. On that
score, I appear to be at odds at the moment with investor consensus, i.e. a
higher chance of an economically meaningful compromise. However, until there are more encouraging
signs to the contrary, my best guess is an agreement that does little other
than keep the economy from running off the cliff.
There is one other
variant to this scenario and that is that the negotiations go down to the eleventh hour, 59th
minute and 59th second. While
the current positive investor mood seems
to indicate a lack of concern about this prospect, it could induce some
heartburn when they actually have to witness our politicians endlessly quibble
and posture for the cameras until they have one foot off the cliff (which as
you know I would consider a potential buying opportunity).
More concerning to me is the
diminishing likelihood that Europe will ‘muddle through’. This week’s Greek bail out is already in
question with the Greek banks refusing to go along. More broadly, the economic news for the whole
of Europe keeps getting worse---unemployment has reached
a high and retail sales are declining.
For whatever
reason, investors appear to care less;
and as long as they do, the eurocrats skate and ‘muddle through’ remains 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).
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.
Last
week, our Portfolios made a bad trade, buying GLD on Tuesday, then selling half
of those shares at a loss on Thursday.
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 13025 1416
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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