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 Uptrend 13024-13653
Intermediate Uptrend 13136-18136
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 1411-1478
Intermediate
Term Uptrend 1387-1982
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 35%
High
Yield Portfolio 35%
Aggressive
Growth Portfolio 36%
Economics/Politics
The
economy is a modest positive for Your Money. This week’s economic data was sparse and mixed:
positives---weekly mortgage and purchase applications. November wholesale
inventories and sales, the December budget deficit and small business sentiment;
negatives---weekly jobless claims and the November trade balance;
neutral---weekly retail sales and consumer credit.
I see little
informative value in these stats; so by default are forecast remains unchanged:
‘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.’
The pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy. The China
The
negatives:
(1) a vulnerable banking system.
This week’s examples: [a] the fine imposed on HBCS for acting as bagman
in laundering funds for the Mexican and Columbian drug cartels and [b] the fine
levied on JP Morgan for foreclosure fraud abuse. While the former doesn’t involve a US
institution, nevertheless they both are 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:
And:
‘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 ‘debt ceiling/sequestration/spending cut cliff’. Well, our
political class snuck past the fiscal cliff though largely because the GOP
folded like a cheap umbrella on spending cuts.
Actually, taken by itself, it was a decent deal. Rates didn’t rise on most taxpayers. The AMT
was fixed. Tax revenues are going
up. So the tax portion of the fiscal
solution was completed in a reasonable manner.
The one discouraging aspect of the legislation was that the bill was
packed with pork, demonstrating the politicians just don’t get the more critical
aspect of our budget problem---spending cuts.
In other words, the danger that
a dysfunctional political class could fail to achieve fiscal sanity has not
diminished; and there are several deadlines ahead that will bring this issue [of
spending cuts] to a head---[a] the effective day of sequestration enacted in
the original budget deal that created the fiscal cliff and [b] the day the
Treasury can no longer pay the government’s bills due to debt ceiling.
Unfortunately potentially exacerbating
the ability to reach a real compromise is
a more combative Obama who has stuck His finger in the GOP’s eyes with His
cabinet nominations and threats of executive action on gun controls. This will likely make the upcoming debate on
spending cuts more acrimonious than the fiscal cliff negotiations and increase the
likelihood that republicans being willing to shut down the government to stand
fast for deficit reduction.
That said, I
still think that some sort of compromise will be reached though it will do
little to improve the fiscal outlook.
There will be much posturing over all the ‘tough’ decisions that had to
be made but the spending cuts will likely be the typical government accounting
gimmicks. So our long term forecast
really won’t change---economic growth hampered by too much government spending
and too high much debt.
Of course, I
could be wrong; our elected representative could (1) agree on a truly
responsible series of budget cuts in which case I would have to raise the long
term growth estimates in our Model or (2) there could be no agreement and we
all get the joys of partial shutdown of the government, a lowering of the
country’s credit rating and a likely slowdown in economic growth which would
necessitate a lowering of our 12-18 month economic growth assumptions [but,
depending on the ultimate resolution, could improve our longer term outlook].
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. Since our last Closing Bell, most global
bankers are now ‘all in’ in the race for who can print the most money the
fastest---the latest FOMC minutes notwithstanding.
‘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 . Not much has changed in the last three
weeks---just don’t tell the families of all the Syrians killed in that time
period. The biggest risk to stability in
the Middle East at the moment may be the changes that
could come in our defense and foreign policies if the newly nominated, more
liberal [pacifist] department heads reflect the future course of While House
policy. If so, it will likely not be
long before Iran Israel Middle East
will almost surely deteriorate and with that the risks increase of a disruption
in production and/or transportation of oil. And that means higher prices
globally that would negatively impact the current recovery.
(4) finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast. The economic and financial news out of Europe
continues to be upbeat and both bond and stock investors are being rewarded
with falling interest rates and rising asset prices. This is clearly supportive
of our ‘muddle through’ scenario if, for no other reason, that it buys time for
the southern EU country economies and financial systems to heal.
That said, in
appears that the eurocrats are using the current lift in investor sentiment to do
nothing but drink more cocktails, smoke more cigars, chase more skirts and
engage in a circle jerk of self congratulation instead of working on policies
that will actually assist the EU to solve its sovereign and bank insolvency
problems. To be sure, the eurocrats may
still pull it off but I see no recent evidence that they will and if they don’t
[and I still think that the odds are high that they won’t], I can’t quantify
the downside and that’s a problem.
And:
Bottom line: the US AMT . That, of course, was the easy part of
necessary fiscal fix.
They now face
the more difficult task of cutting spending; and the initial signs are not
good: (1) they loaded the tax reduction bill with pork and (2) Obama spent the
week sticking His thumb in the GOP’s eye via cabinet nominees and threats of
unilateral action on gun control.
Certainly, He has the right to select those who serve on His cabinet;
but at a time when it will take bipartisanship and compromise to achieve a
spending cut deal---which is unquestionably the most important issue facing our
government at this moment---antagonizing the opposition is probably not the
best strategy.
That doesn’t
mean that an agreement won’t be reached before the debt ceiling forces a
partial shutdown of the government; but the risks are there. As important, I expect the final compromise will
be mostly smoke and mirrors anyway consisting largely of typical phony
government accounting. Hence, nothing
that will alter our long term forecast of sub par economic growth for as far as
the eye can see.
The Fed
continues to do what it does best---run the printing presses 24/7. The minutes of the last FOMC meeting offered
a glimmer of hope (concern the Fed was too easy). However, I believe that as long as Bernanke,
Yellen and Dudley rule the FOMC, the Fed will remain irresponsibly easy. Sooner or later, this will almost surely lead
to higher inflation for the simple reason that the Fed has never managed a
transition from easy to tight money correctly---always staying too loose for
too long.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies. The good news is that economic conditions
appear to be improving somewhat and investors are maintaining their faith that
Draghi’s ‘anything necessary’ monetary strategy will triumph. That buys time for the eurocrats to fix the
sovereign and bank solvency problems---so the ‘muddle through’ scenario remains
operative. The bad news is the eurocrats
continue to fiddle f**k around and not deal with those problems; and as long as
they do, the risk of crisis remains.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications rose,
(2)
consumer: weekly retail sales were mixed; weekly
jobless claims rose more than expected, November consumer credit was up but
largely due to student loans,
(3)
industry: November
wholesale inventories were stronger than anticipated while wholesale sales
soared; small business sentiment rose slightly from a depressed level,
(4)
macroeconomic: the November trade deficit widened
sharply while December budget deficit narrowed much more than expected.
The Market-Disciplined Investing
Technical
The indices (DJIA
13488, S&P 1472) continue to trade in both their short term uptrends (13024-13653,
1411-1478) and their intermediate term uptrends (13136-18136, 1387-1982). That said, they do have a challenge ahead in
the form of the old 13682/1474 highs.
The current pin action certainly suggests that this resistance level
will be taken out; if so, the next challenge is up at 14140/1576.
Volume on Friday
fell; breadth was mixed. The VIX was down
a little, remaining within its recently re-set intermediate term
downtrend. However, it has a formidable
technical barrier at only a slightly lower level.
So both the
Averages and the VIX are facing important technical resistance (support) levels
that could at the very least force additional consolidation. Hoping to get some additional perspective, I
ran a study on our own internal indicator with the following results: in a 154
stock Universe, 87 were above their comparable S&P 1474 level, 50 were not
and 17 were too close to call. That
clearly points to an upside bias. So if
I had to guess today, I would think that the S&P breaks above 1474 and continues
to at least the 1576 resistance level.
GLD was down
fractionally, and 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 Averages are in a short term uptrends [13024-13653,
1411-1478] as well as intermediate term uptrends [13136-18136, 1387-1982].
(2) 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 (13488)
finished this week about 19% above Fair Value (11325) while the S&P (1472) closed
4.9% overvalued (1403). Incorporated in
that ‘Fair Value’ judgment is some sort of compromise on the fiscal (debt
ceiling/sequestration/spending cut) cliff, a ‘muddle through’ scenario in Europe
and a lowering of the long term secular growth rate of the economy.
As you know, we
got the easy half of the ‘some sort of compromise on the fiscal cliff’. Taxes were raised, though on a smaller
portion of the tax paying population than I expected. That’s the good news; the bad news is the
legislation was stuffed with pork (increased spending). That along with Obama’s re-newed adherence to
ideological purity suggests that the spending cut half of the deal may be a bit
more difficult to achieve.
As important,
even if this gets done without a Market panic and/or partial shutdown of the
government, the spending cuts will likely be illusory, leaving the economy and
the Market to continue to bear the consequences of too much government spending
and too much debt. I am apparently in
the minority on this opinion in view of the current Market run which suggests
that investors are assuming a much more fiscally sound compromise without big
problems. They may be correct; but until
the politicians prove that they are capable of doing the right thing on
spending, the assumptions going into our Economic and Valuation Models are that
they won’t.
The bad news
is that (1) as noted above, the eurocrats are doing nothing to fix the
deplorable state of southern EU bank and sovereign solvency and (2) I don’t have
a clue as to how to quantify not ‘muddling through’---though I do believe that
the consequences will be severe. That
said, the ‘muddle through’ assumption in our Valuation Model is working; so I
leave it until it doesn’t.
My investment conclusion: the tax side agreement of the fiscal cliff was
passable; however, I don’t believe much real progress will be made on the
spending side, leaving the economy straining to grow against the headwinds of
too much spending and too much debt. That, of course, is our economic forecast so
our Valuation Model remains unchanged.
However, the potential turd in the
punchbowl is a lack of any agreement that leads to a partial shutdown in the
government. While I don’t view this as
necessarily bad for the long term (if it were to lead to real, meaningful
spending cuts), it would undoubtedly negatively impact the economic outlook for
the next twelve months and hence short term equity valuations.
No economic good will likely come from
QEIV. Rather, as I have opined
previously, 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 not only the level of economic activity but also the rate
at which that activity (and future earnings) is valued (discounted). ‘Or later’ is clearly the operative phrase
because so far I have been dead wrong on the timing of a rise in
inflation---which may account for some of the difference in our Fair Value
estimates versus what appears to be Market consensus. However, given what I believe in its
inevitability, I am sticking with this assumption.
The more significant issue is the
fragility of the EU banking systems
caused by their massive investment in impaired assets (their governments’
bonds), the lack of financial controls and the continued atmosphere encouraging
inappropriate risk taking by proprietary trading operations. When, as and if the Markets ever decide to
challenge banking policies and valuations, global market could be in for a
rough ride. Since I can’t quantify this
risk, my solution to this dilemma is to carry an above average cash position as
insurance.
I am clearly aware the current investment strategy puts me in direct conflict
with Market consensus. I am also aware
that our Portfolios are experiencing a not insignificant opportunity cost
carrying a large (virtually non interest bearing) cash balance.
It is particularly difficult at a time
that I also believe that the economy will continue to make progress. But unless I plug into our Models what I
believe are unrealistic assumptions that lead to an increase in the secular
growth rate of the US
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 [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 2013 Year End Fair Value*
11600 1440
Fair Value as of 1/31/13 11325 1403
Close this week 13488 1472
Over Valuation vs. 1/31 Close
5% overvalued 11919 1473
10%
overvalued 12457 1543
15%
overvalued 13023 1613
20%
overvalued 13590 1683
Under Valuation vs.1/31 Close
5%
undervalued 10758 1332
10%undervalued 10192 1262 15%undervalued 9626 1192
* 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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