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 13140-13797
Intermediate Uptrend 13211-18211
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 1430-1498
Intermediate
Term Uptrend 1398-1993
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. It was a slow week for economic data; and what
little we got was mixed to slightly negative: positives---weekly mortgage and
purchase applications, weekly jobless claims and December leading economic
indicators; negatives---the December Chicago National Activity Index and the
January Richmond and Kansas City Fed manufacturing indices, existing home sales
and new home starts; neutral---weekly retail sales.
These stats were
certainly not on par with the data from the last month or so; however, (1) they
weren’t bad; they just weren’t great and (2) they were not unexpected. As I noted in last week’s Closing Bell ‘The temptation is to get overly jiggy
with this trend (i.e. the recent string of great stats).
However, as you know the last three years have witnessed a somewhat
erratic flow of data: a series of positive stats followed by a string of
negative to neutral numbers.’
Also keeping me
somewhat cautious in our outlook is (1) the negative impact on aggregate
economic activity coming from the recent reinstitution of the FICA tax and (2)
this week’s debt ceiling extension notwithstanding, I am not optimistic about
the ultimate outcome of the debt ceiling/sequestration/continuing resolution
negotiations. Hence, 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.’
The
latest from Robert Shiller (4 minute video):
The pluses:
(1) our improving energy picture.
The US
Aiding this factor, this
week the Nebraska US
(2) an improving Chinese economy. This week, Chinese PMI
came in ahead of estimates. As you know,
I list this factor with the caveat that the Chinese lie about everything
including their economy.
The
negatives:
(1) a vulnerable banking system.
This week, [a] an assistant Attorney General admitted publicly that the
DOJ did not pursue criminal charges against major bank managements after the
financial crisis for fear of causing a panic in the global securities markets---for
which he was promptly fired and [b] the world’s oldest bank {Italian} had to be
rescued after incurring enormous losses in the derivatives markets whilst Mario
Draghi was Italy’s central banker.
Oooops.
‘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.’
Central bank failures (medium/long):
(2) the ‘debt ceiling/sequestration/continuing resolution cliff’. In a
move reflective of the eurocrats, the can [i.e. the difficult task of cutting
government spending] got kicked down the road again this week by our own ruling
class. The house voted to extend the
debt ceiling for three months---which may leave the securities markets in
blissful ignorance, but it does nothing to deal our problem [too much spending
and too much debt].
Of course,
there are other deadlines, i.e. that of the sequester [March 1] and the
continuing resolution [April 15]. And it
is anybody’s guess at which of these our politicians actually face up to my spending
cut ‘the line in the sand’---if, in fact, they ever do. That ‘line’ being whether they either put
government finances on a fiscally responsible course or they don’t.
It matters not
whether these clowns avoid an emotionally charged negotiating process or a
government shut down. It matters what
they agree to. Because if they side step
a budget crisis by agreeing to some half assed set of spending cuts, then we as
taxpayers are f**ked long term whether or not we as investors may benefit short
term from a positive market reaction to a compromise.
As you know, I don’t believe that the political will exists to return
the country to fiscally responsible management. Of course, I could be wrong and
I hope that I am. But the point
remains---‘I believe that the upcoming
spending cut discussions are critical in the sense that they are a signpost on
the direction of this country. A failure
to act fiscally responsible will likely lead to a permanent decline in the
future growth rate of this country’s economy, hampered as it will be by too
much government spending, too much government debt to service, too much phony
money floating around the economy and too much regulation.’
To be clear,
this isn’t a disaster scenario---after all, Europe has
been doing it for years. It is just not
as good as it could be and it does move
the country closer to the potential for more severe usurpation of financial and
individual rights.
Here is another optimist a la Krauthammer with the hope that somehow
2014 will bring the change needed to right our fiscal ship (medium):
Counterpoint
(medium):
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 an 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. Yesterday, the Fed announced that its balance
sheet now holds $3 trillion in assets and will likely be a $4 trillion by year
end.
And
here is what we received for that $3 trillion (short):
‘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 . The below link is an analysis of what lay
behind the Algerian terrorist attack.
Bottom line---there is more to come and it is going to increase the cost
of extracting Middle Eastern oil and gas.
http://www.zerohedge.com/news/2013-01-24/guest-post-energy-industry-doesnt-understand-algeria-attack
(4)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast. The economic and financial news improved
again this week with the EU PMI reported
slightly ahead of expectations and larger than expected pay down of the ECB’s
LTRO lending facility---providing additional ammo for investor complacency.
On the other
hand, a major scandal is breaking in Italy
And there is more
unhappy news, youth unemployment soaring (short):
That said, the
euro remains strong and the European securities markets are acting as if all is
well---although the latter is largely a function of less stress on the
financial system [i.e. low interest rates] and has little to do with
improvement in the underlying fundamentals.
In other words, the collective EU economies are a mess, countries and
banks remain overleveraged and the banking community’s exposure to the
derivative markets is basically unknown [witness the E700 billion problem in
the Italian bank].
Nonetheless, as
long as this far too sanguine attitude continues, it keeps our ‘muddle through’
scenario in place and buys time for the southern EU economies to heal and the
eurocrats to implement corrective policies.
Regrettably, those guys are spending most of their time in self
congratulatory celebration instead of attempting to fix the problem ---which
keeps the odds of this risk occurring higher than it could be.
Bottom line: the US economy continues to grow (slowly) with
the recent month long burst of solidly positive economic reports giving way to
the longer term trend of more erratic progress.
That’s OK, because that fits our forecast---an economy struggling to
grow.
Our ruling class
continues to make no headway in resolving our fiscal problems. The GOP did come up with legislation this
week that while extending the debt ceiling till May stipulated that the budget
would be balanced in ten years and if there is no budget, the senate doesn’t
get paid. That sounds great on paper but
(1) so far the closest the republicans have come to a balanced budget is Ryan’s
version and that didn’t balance the budget for over twenty years and (2) Reid
agreed that the senate would pass a budget but it would include tax
increases. In other words, it is
business as usual among our ruling class.
I opined last
week that the negotiations on the debt ceiling/sequestration/continuing
resolution were, in my mind, a line in the sand as related to the future course
on our economy, i.e. either these clowns gut it up and put this country on a
path to fiscal responsibility or the US slides inevitably toward the European
socialist, nanny state model.
My money is on
the latter, though Charles Krauthammer suggests that the current standoff could
last until the 2014 elections, in which the electorate realizes the error of
its way, returns a GOP dominated senate to complement the house and that marks
the beginning of a return to lower spending, lower taxes and smaller deficits. Even
if he is right (and I think that the odds are well short of 50/50), that does
nothing to alter our forecast for the next 18-14 months---an economy on a long
term growth path that is below average for this country, impaired as it will be
by excessive spending, taxing, money printing and regulations.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies. While our forecast is ‘muddling through’, it
concerns me that the eurocrats have done little to nothing to address the
underlying causes of the fiscal imbalances in Europe . Even worse, the magnitude of this risk is
unknowable as the current fiasco in Italy
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up; December existing home sales fell more than anticipated as did new housing
starts,
(2)
consumer: weekly retail sales were mixed; weekly
jobless claims were quite strong,
(3)
industry: the December
Chicago Fed National Activity Index was well below expectations; both the
January Richmond and Kansas City Fed manufacturing indices were disappointing,
(4)
macroeconomic: December leading economic indicators
rose more than forecast.
The Market-Disciplined Investing
Technical
The indices
(DJIA 13894, S&P 1502) had a good week: (1) their break out above the
13682/1474 resistance level was confirmed, (2) both closed above the upper
boundary of their short term uptrend [13140-13797, 1420-1498] and (3) both
finished well within their intermediate term uptrend [13211-18211,
1398-1993]. Blue skies smilin’ at me.
The upper
boundaries of the Averages short term uptrends have clearly not hampered the
rate of advance---which suggests the underlying momentum is super charged and
probably assures that the indices will at least test the 14140/1576 resistance
level.
Volume on Friday
was up slightly; breadth continued strong.
On the other hand (1) the VIX was up---a little unusual for a good up
day in prices. It also looks like it is
trying to form a bottom in the 12-13 level---‘trying’ being the operative word
because it is much too soon to confirm, (2) sentiment indicators are reaching
dicey levels and (3) perhaps ominously, some of the bond indices and ETF’s that
I follow are starting to breakdown technically.
Again it is too soon to know if rates [prices] are finally starting up
[down]; but if they are, then one of the main arguments that equity investors
have been using of late to rationalize chasing stocks up [i.e. there is no
other asset in which I can earn a competitive return] would disappear.
Credit Suisse
indicator of risk appetite (short):
GLD was down and
remains in a short term downtrend and an intermediate term trading range. It closed right on the lower boundary of a
very short term uptrend. How it handles
this support level with tell us something about the strength of the underlying
bid.
Bottom
line:
(1)
the Averages are in a short term uptrends [13140-13797,
1430-1498] as well as intermediate term uptrends [13211-18211, 1398-1993].
(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 (13893)
finished this week about 22.6% above Fair Value (11325) while the S&P (1502)
closed 7.1% overvalued (1403). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed compromise on the
fiscal (debt ceiling/sequestration/continuing resolution) cliff, continued
money printing, a historically low long term secular growth rate of the economy
and a ‘muddle through’ scenario in Europe .
I continue to
that think the upcoming debt ceiling/sequestration/continuing resolution discussions will probably not lead to a
shutdown in the government---saving us from the kind
chicken-little-the-sky-is-falling-panic-sell-off that often accompanies these
events.
On the other
hand, I also fear that our political class is unable or unwilling to deal with
their past profligacy---which means that our three to five year outlook is
about the same as our 12-18 month forecast: an economy managing to grow at a
sub par rate in spite of the burdens of too much government spending, too high
taxes, too high debt, too much government regulation and too much money sloshing
around in the system. This will remain our
base case for the assumptions in our Valuation Model until/unless our elected
representatives prove otherwise.
The latest from
Marc Faber:
I recognize that mine is a minority view as
witnessed by the current Market run; and I accept that the Krauthammer thesis (see
above) is possible. However, I have to
deal today with the arithmetic of run away government spending and a Fed determined
to break the intergalactic speed record for printing money and their impact on both
the economy and security valuations. To
date, the results of that analysis haven’t changed. I simple can’t get an economy growing any
faster than it is currently and I can’t get stock valuations higher.
‘Europe
continues to ‘muddle through’ aided by investors’ belief that the eurocrats
have contained the continent’s sovereign/bank debt problem. Of course, they are doing nothing to fix the
economic disaster that is southern Europe ;
so I don’t believe for a second that the economic risk of recession or the
financial risk of serial derivative defaults by EU banks have diminished. But as long as the Markets give the eurocrats
a free ride, the danger of some imminent calamity is held at bay and time is
bought for the eurocrats to hopefully do something meaningful.’
My investment conclusion: sub par growth of the US
I noted last week that I believe ‘that our dysfunctional political process
has reached an important crossroad---either the ruling class ceases its
profligate spending and recognizes that it is not omniscient regarding how its
citizens regulate their own lives or the wise course is to start distancing
ourselves from that government.’
I have started that process. I am now doing the analysis on other asset
classes that can provide some diversification away from US equities. These include both foreign and domestic
REIT’s, hard assets plays such as straight commodity or oil ETF’s and foreign ETF’s that focus on dividend growth.
In addition, an associate will be going
to Panama next month as a first move in exploring that country’s banking and
real estate laws and gaining a more general look at the political, social
environment as well as established ex pat communities. Further trips are planned to Costa
Rica Ecuador Bermuda .
That said, I want to reiterate these
steps are precautionary. It is part of
the process of thinking through the investment and life style alternatives
available if the current monetary, fiscal and regulatory polices continue and
when, as and if their consequences began to seriously threaten our hard earned
economic security. We may never need to
avail ourselves of any of these potential alternative strategies. But forewarned................
Getting back to the present, our
Portfolios will continue to raise cash from overvalued, overextended stocks
with the intent of redeploying the proceeds into the aforementioned asset
classes.
Last
week, our Portfolios Sold additional shares and left the proceeds in cash
equivalents.
So far this earnings season is a disappointment, investor euphoria
notwithstanding (medium):
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 13894 1502
Over Valuation vs. 1/31 Close
5% overvalued 11919 1473
10%
overvalued 12457 1543
15%
overvalued 13023 1613
20%
overvalued 13590 1683
25%
overvalued 14156 1753
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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