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 13093-13759
Intermediate Uptrend 13179-18179
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 1421-1490
Intermediate
Term Uptrend 1393-1993
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. This week’s economic data was tilted heavily
to the plus side: positives---weekly mortgage and purchase applications. December
housing starts, December industrial production, weekly jobless claims, December
retail sales, November business inventories and sales, PPI; negatives---December
consumer sentiment, the NY and Philly Fed manufacturing indices; neutral---weekly
retail sales and CPI .
These stats are
very encouraging coming as they do on a string of generally upbeat weekly
reports. They clearly confirm our
positive economic growth scenario and keep the recessionistas at bay. The temptation is to get overly jiggy with
this trend. 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. In addition, (1) there is a negative impact on
aggregate economic activity coming of the recent tax increases and (2) I am not
optimistic about the ultimate outcome of the debt
ceiling/sequestration/spending cut negotiations, i.e. nothing fiscally
responsible will come out of them.
Hence, for the time being, I am sticking 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.’
New
Update on the big four economic indicators:
The pluses:
(1) our improving energy picture.
The US
However, Goldman sees oil at
$150 this summer (short):
(2) an improving Chinese economy. This week, Chinese GDP ,
industrial production and retail sales were all reported above
expectations. To be sure, everyone knows
that the Chinese make numbers up if they don’t fit the narrative. However, given the global economic
improvement that we are seeing, I will stipulate that, at the least, the
Chinese economy is growing and likely at a faster pace than our own.
The
negatives:
(1)
a vulnerable banking system. This week the German central bank asked for a
portion of its gold currently held in New York London Paris
In another
development, the study by the JPM task force
investigating the massive CIO loses was released. Here is an excerpt (medium and a must read):
‘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’. Having been reasonably successful in
negotiating the ‘fiscal cliff’, our political class is now faced with
additional deadlines tied to [a] the debt ceiling, [b] the effective date of
the sequestration part of the ‘fiscal cliff agreement and [c] the need to
either produce a budget or pass a ‘continuing resolution’. Getting through those hurdles is apt to be more difficult
than the tax extension compromise.
But before
getting into that aspect of our budget dilemma, I want to back track on the tax
increase portion of the problem. I said
last week that I thought the outcome was reasonably positive because [a] the
fiscal cliff was averted, [b] income taxes were raised on only a small
percentage of Americans and [c] the AMT was
fixed. However, I failed to note that in
addition to the tax increases on ‘the wealthy’, FICA taxes will resume. I have seen estimates that these two taxes
along with the new Obamacare taxes could reduce household income by 2-3% this
year. While this is not an earthshaking
number, it will have a consequence, adding yet another drag on economic
growth. I am not altering our forecast;
but I am warning that I could as the impact of these taxes shows up in first
quarter 2013 data.
Now back to the debt ceiling: I have opined that I believe that the GOP
will probably not shut down the government over the debt ceiling negotiations;
but that they would make a stand during the debate on one or more of the debt
deadlines mentioned above. Friday
afternoon, the republicans announced that they would be willing to pass a three
month rise in the debt ceiling IF the senate passed a budget [something that
they haven’t done in four years] and if not, then they don’t get paid.
This maneuver accomplishes a couple of things: [a] Obama and dems can’t
accuse them of wanting to shut down the government or not pay the government’s
bills, [b] they are asking for something perfectly reasonable from the dems---which
puts the ball back in their court and [c] it is incremental and repeatable.
Whether it works or not is anyone’s guess at this point. More importantly, if it does work, I am not
sure just how much fiscal responsibility the GOP will insist on. At the moment, my best guess is that any cuts
will likely be more accounting fluff than a real stab at fiscal
responsibility.
Of course, I could be wrong and meaningful spending reductions will be
enacted. I hope that I am wrong.
Whatever the outcome, I believe that this debate represents a line in
the sand. That is, if our political
class doesn’t act decisively to reduce the size of government intervention in
the economy, I think that we will have taken another giant step toward becoming
a European style big government nanny state.
Not to wax too philosophical here, but this country’s founding document is
a Constitution that narrowly defined the role of government and left everything
else to the states and citizens. We have
reached a point where our government is doing the exact opposite: creating and
funding regulations that address ‘everything else’ while simultaneously
ignoring its defined role, e.g. producing an annual budget [protecting the
right to bear arms?].
I personally find it unacceptable that each of us has to live within our
means---I don’t know about you, but the last four years witnessed some harsh
fiscal steps in my household---while our political class goes on its merry way,
raising its own salaries, throwing money at its constituent rent seekers,
bailing out [with no penalties, I might add] a banking class that nearly
destroyed our economy and financing it all by taxing a small percentage of the
electorate and incurring an inexcusable level of debt that will only be repaid
via a debauched currency and taxing that same small percentage of the
electorate.
OK, I have vented enough. But my
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. 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.
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. This week, the Japanese basically doubled
down on their new ‘all in’ strategy. The
PM made a Draghi-like ‘what ever is necessary’ pledge, which I assume will
shove their money printing into overdrive.
‘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.
Growth
in GDP versus growth in money supply
(short):
Update
on inflation (new):
And
this must read:
[b] a blow up in the Middle East . The terrorist action in Algeria Syria Libya
The point here,
is that if the bad guys change tactics from blowing up ships, barracks and
embassies to blowing up refineries, pipelines and production facilities, then the
risk of higher oil prices will definitely rise.
(4)
finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast. The economic and financial news turned a bit
sour this week, interrupting a couple weeks of more promising data. Certainly, this could just be a hiccup; but
it clearly punctuates the risk that all may not be well in Europe .
Posted without
comment (short):
On the other
hand, the euro remains strong and the European securities markets are acting as
if all is well. As long as this 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.
The problem is, the latter ain’t happenin’---which keeps the odds of
this risk occurring higher than it could be.
Bottom line: the US
Our ruling class
continues to do what it does best---which is spend our money. To be sure, they avoided a crisis with the
compromise over taxes. However, they
loaded that legislation as well as the Sandy relief bill
with pork; and that doesn’t augur well for a meaningful attack of government
spending. As you know, there are several
‘deadlines’ that still lie ahead related to spending cuts, to wit, the debt
ceiling, sequestration and the continuing resolution. Those offer great opportunity for our elected
representatives to do the right thing, fiscally speaking. However, while I think that we will likely
avoid an emotional crisis ala the fiscal cliff accord, I have little confidence
that meaningful spending cuts will be forthcoming---the recent proposal by
house republicans notwithstanding. That
leaves our 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’, what
is disconcerting to me is that (1) the eurocrats are spending all their time in
self congratulatory praise for having averted a crisis while doing nothing to
correct its underlying causes and (2) I don’t have a handle on how to quantify
not ‘muddling through’---which itself adds to the risk.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up a lot; December housing starts were gangbusters,
(2)
consumer: weekly retail sales were mixed while December
retail sales were stronger than expected; weekly jobless claims dropped more
than forecast; December consumer sentiment was below both estimates and the
prior month’s report,
(3)
industry: December
industrial production increased more than anticipated; November business
inventories were up and sales were up even more; both the January NY and Philly
Fed manufacturing indices were weaker than expected,
(4)
macroeconomic: December PPI came in much tamer than forecasted
while CPI was right in line; the Fed Beige
Book offered little new information.
The Market-Disciplined Investing
Technical
The S&P
(1485) finished for the second day above the 1474 resistance level. Under our
time and distance discipline, it will confirm the break if it finishes above
1474 at the close Wednesday. Meanwhile,
the DJIA (13649) edged closer to its comparable level (13682), but has yet to
penetrate it.
That leaves the
Averages out of sync in only a minor way since both the short and intermediate term trends are still to the
upside. All signals continue to point to
a move higher to at least the 14140/1576 level though the advance may be
tempered by the upper boundaries of the Averages short term uptrends
(13093-13759, 1421-1490). Both remain
within their intermediate term uptrends (13179-18179, S&P 1493-1988).
Volume on Friday
soared though breadth was mixed. The VIX
plunged, closing within its intermediate term downtrend---very positive for
stocks.
Bullish
sentiment nears extreme levels (medium):
GLD was down
fractionally and remains in a short term downtrend and an intermediate term
trading range. However, it did manage to
finish above the upper boundary of a very short term downtrend as well as the
lower boundary of a very short term uptrend---a hopeful sign.
Bottom
line:
(1)
the Averages are in a short term uptrends [13093-13759,
1421-1490] as well as intermediate term uptrends [13179-18179, 1393-1988].
(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 (13649)
finished this week about 20.5% above Fair Value (11325) while the S&P (1485)
closed 5.8% overvalued (1403). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed compromise on the
fiscal (debt ceiling/sequestration/spending cut) cliff, continued money
printing, an historically low long term secular growth rate of the economy and
a ‘muddle through’ scenario in Europe.
As I opined
above, I think the upcoming debt ceiling/sequestration/spending cut discussion
will probably not lead to a shutdown in the government; but it will also not
get the country any closer to fiscal sanity.
Of course, I could be wrong but given that both the tax and Sandy
relief legislation were laden with pork and Obama continued adherence to His
ideological purity, I think that the burden of proof is on those who believe Washington
All that said,
the point here is not political (notwithstanding my rant above), it is economic:
that is, if our political class is unable or unwilling to deal with their past
profligacy:
(1)
How fast can American business grow its earnings and
how do you value those profits when it appears increasingly likely that the
future will bring more taxes, a more
difficult environment to raise capital and a rising regulatory burden? My answer is that slower economic growth,
lower rates of return on capital and higher inflation means historically below
average earnings growth and higher discount factors [lower P/E’s],
(2)
Are there better places to invest our money and house
our assets than the US US US
I hate this
whole Cassandra, Dr. Doom routine. I
would love to be optimistic about the future.
But the facts are what they are; and we either adjust or we allow our government
to take an increasing share of our wealth either through rising taxes or
insidious inflation.
Charles
Krauthammer with the closest thing to an optimist’s view (medium):
I recognize that mine is a minority view as
witnessed by the current Market run.
Clearly a majority of 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.
My investment conclusion: sub par growth of the US
In
the past, when stocks (as defined by the S&P) are 5% overvalued that has
not prevented us from spending cash on those equities that are on our Buy
Lists. However, the ‘fat tails’ of the
current risks that we face are of such a magnitude that my judgment is to hold
off most purchases, maintaining a large cash reserve to protect principle.
Looking longer term, 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. This can’t and shouldn’t be done in one fatal
swoop; but slowly and thoughtfully. After
all, we can never know when or if our leaders might suddenly realize the error
of their ways.
My first steps will be to diversify more
of our Portfolios’ assets in non US US
Future steps if they become necessary
will be to establish a financial presence overseas and then build those
commitments if conditions in the US
Returning to the more immediate issues, I
am clearly aware that the current investment strategy puts me in direct conflict
with Market consensus. I am also aware
that our Portfolios are experiencing a substantial 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 High Yield Portfolio Sold one half of its holding of Sanofi American
and re-invested the proceeds in Pioneer Southwest Energy.
Four dubious assumptions driving the Market higher (medium):
Update
on revenue and earnings ‘beat’ rate so far (short):
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 13649 1485
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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