The Closing Bell
I have a family reunion to go to this weekend in Houston
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 13245-13879
Intermediate Uptrend 13263-18263
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 1438-1508
Intermediate
Term Uptrend 1402-1997
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 36%
High
Yield Portfolio 36%
Aggressive
Growth Portfolio 39%
Economics/Politics
The
economy is a modest positive for Your Money. The volume of data this week was largely positive,
though the poor fourth quarter GDP headline
number caused something of a stir: positives---the Case Shiller home price
index, the ADP private payroll report,
December personal income, December durable goods, the January Dallas Fed
manufacturing index, Chicago PMI , January PMI ,
the November/December revisions to nonfarm payrolls, January consumer
sentiment, the January ISM manufacturing index and construction spending;
negatives---weekly mortgage and purchase applications, weekly jobless claims, unemployment,
fourth quarter GDP ; neutral---weekly retail
sales, January nonfarm payrolls and December personal spending.
Save the fourth
quarter GDP and unemployment reports, I
would say that this week’s numbers were pretty darn good. And as noted in Thursday’s Morning Call, I
don’t really think that there is that much
negative about the GDP number once you
analyze its composition---government spending was down big but housing,
consumer spending and business investment all did fine. Indeed, that analysis offers some hope;
namely that the impact of sequestration, were it to happen, would not be nearly
as negative for the economy as I might have thought earlier.
That said, it is
too early to extrapolate the GDP results
into the affects of sequestration.
Further, we have yet to see the impact of the recent tax increases. So bottom line, I am not altering our
forecast though I admit that I am a bit more hopeful---assuming that our
politicians don’t use the GDP report as a
cause celebre for not cutting spending.
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.’
And:
Update
on the big four economic indicators:
The pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy.
The
negatives:
(1) a vulnerable banking system.
This week, [a] it became clear that Draghi, when head of the Italian
central bank, knew about financial mismanagement in the latest Italian bank
scandal, [b] several UK banks are going to get dinged hard for misconduct in
the derivatives market and [c] a large Dutch bank went toes up due to massive
real estate losses.
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/continuing resolution cliff’. With
the issue of the debt ceiling out of the way, attention now shifts to the
sequestration deadline [March 1]. So far
the republicans are holding firm that the sequestration spending cuts will take
place.
In addition, as
noted above, it is encouraging that the latest GDP
report bears some witness to the notion that government spending can be reduced
without seriously affecting the rest of the economy.
However, [a]
the senate has said that they will pass a budget but it will include more tax
increases, leaving open the chance that the GOP could once again get out maneuvered
in the budget negotiations and only token budget cuts will result and [b] while
I haven’t heard this excuse yet, I worry that the politicians will use the GDP
headline short fall as a rationale for increased government spending.
So the whole
issue of spending cuts remains very much up in the air; and I maintain my
thesis that this is ‘a line in the sand’ moment in our history--- the ruling
class either puts government finances on a fiscally responsible course or they don’t. And if they don’t, then I submit that the
taxpayers of this country are totally screwed.
To be clear, America US
http://www.zerohedge.com/news/2013-01-31/short-term-palliatives-and-5-terrible-tendencies-government
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. I have detailed in these pages the rise in
the number of central banks that have gone ‘all in’ jacking up their growth
rate in money supply. In the initial
phases, it was received with general investor approval because this new money
was juicing stock prices.
Now some are
becoming worried about a natural outgrowth of these irresponsible policies: the
risk of a currency war---in which the purpose of rapid monetary expansion goes
from spurring internal growth to the depreciating currency so as to improve the
external competitiveness of nation’s products.
The problem, as
I have been attempting to document this week, is that if everyone is starting
to jump on the bandwagon, the end result is that no single country gains a leg
up and global inflation is the ultimate outcome.
While we may
not yet be at defcon 1 in this potential economic conflict, the seeds are being
sown; and if the central bankers aren’t careful, this could grow into more than
just an inflation problem.
‘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 . Israel Egypt US Ankara
(4)
finally, the sovereign and bank debt crisis in Europe
remains a major risk to our forecast. The economic news turned lousy again this
week, while Italy Spain UK
On the other
hand, investor complacency is high, the euro remains strong and the European securities
markets are acting as if all is well. In
other words, the collective EU economies are a mess, countries and banks remain
overleveraged and while the banking community’s exposure to the derivative
markets is basically unknown, it is getting bigger by the day as more scandals
reveal ever larger commitments to derivatives. [witness the UK
‘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 GDP
number notwithstanding. Indeed as I have
noted many time, the ingenuity and hard work of the corporate sector has managed
to sustain growth despite the burdens imposed by our politicians. Nonetheless, those burdens remain and serve
to stymie the rate of growth. That
remains our forecast.
Our ruling class
has made no headway to date in resolving our fiscal problems. The GOP is insisting that the scheduled
sequestration of spending will take place on March 1. I hope that is the case; but so far, those
are only words. Regrettably, there have
been zero actions to back up the rhetoric.
Until that occurs, color me skeptical.
Further, I maintain
my position that the negotiations on the debt ceiling/sequestration/continuing
resolution are 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.
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 fiascos in Italy UK
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
down; the November Case Shiller home price index rose more than anticipated,
(2)
consumer: weekly retail sales were mixed; the ADP
private payroll report was down less than forecast; weekly jobless claims were unusually
weak; January nonfarm payrolls were up less than expected but November and
December were revised up big; unemployment rose; December personal income
soared [though it was mostly a function of those big, tax avoidance dividends and
bonuses paid ahead of the resolution of the fiscal cliff] while personal
spending rose only fractionally; the January consumer confidence index was a
major disappointment, while the University of Michigan’s final January index of
consumer sentiment was well over
forecasts,
(3)
industry: December
durable goods orders were gangbusters; the Dallas Fed manufacturing index was
better than expected; Chicago PMI was very
good while January PMI was in line; the
January ISM manufacturing index was much better than anticipated, as was
December construction spending,
(4)
macroeconomic: the initial fourth quarter GDP
report was negative.
The Market-Disciplined Investing
Technical
The indices
(DJIA 14009, S&P 1513) had another good week: (1) both closed above the
upper boundary of their short term uptrend [13245-13879, 1438-1508] and (2)
both finished well within their intermediate term uptrend [13263-18263, 1402-1997].
While trading
earlier in the week suggested that the upper boundaries of the Averages short
term uptrends may be holding back their rate of advance, the explosion on
Friday hinted at something entirely different, to wit, that those upper
boundaries may be acting more as support than resistance.
What makes
Friday’s move all the more impressive is that the headlines were mediocre at
best. January nonfarm payrolls were
below expectations (though November and December were revised up), the
unemployment rate was up and terrorists bombed the US Turkey
Volume on Friday
was down slightly; breadth rose strong. The
VIX fell 10%, closing within its intermediate term downtrend---a positive for
stocks.
On the other
hand, sentiment indicators continued to deteriorate and some of the bond indices and ETF’s that I
follow are clearly breaking down technically. Interestingly enough on the latter point, the
bulls are starting to shift their rates-are-too-low-I-have-to-own-stocks
argument to stocks-do-OK-as-long-as-the-long-rate-is-below-5% position. Whether or not that proves true, short term
the point is that if you own long bonds, you probably need to be lightening up.
Another sell
signal triggered (short):
GLD rose. While it is holding above the lower boundary
of a very short term uptrend, it also remains within a short term downtrend and
an intermediate term trading range.
Bottom
line:
(1)
the Averages are above the upper boundaries of their short
term uptrends [13245-13879, 1438-1508] and within their intermediate term
uptrends [13263-18263, 1402-1997].
(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 (14009)
finished this week about 23.4% above Fair Value (11350) while the S&P (1513)
closed 7.6% overvalued (1406). 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 .
Nothing in the
economic data suggests a change is required in the assumptions in our Valuation
Model. However, if the
sequestration/continuing resolution negotiations lead to a real plan to reduce
the government spending and total debt as a percent of GDP ,
then I will revise our long term economic growth rate assumption. Not only will that improve corporate profit
growth but would likely expand valuations (P/E).
That said, I
have little faith in that outcome and, hence, have no intent in making any
changes in our Models until proof that they are serious.
I know all to
well that our economic/valuation assumptions are in direct conflict with the
Market consensus. But based on the data
available, I can’t get valuations to current levels. I am not saying that the economy is a
negative or that corporate profits won’t continue to grow. I am saying that based on the fact pattern
before us, the economy will not return to its historical growth rate and that
there are risks associated with the current irresponsible management of fiscal
and monetary policies that have to be accounted for in making valuation
judgments. Given that, 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
Perhaps more important, my concern about
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 begin a serious effort to protect our ourselves from further
mischief.
While we don’t know which course they
will choose, there are some immediate steps that can be taken is to insulate
our assets from the potential fallout from a heavily indebted government and a
bloated Fed balance sheet. That means
continuing to lower our Portfolios’ exposure to fundamentally overvalued,
technically overextended stocks and gradually redeploying the proceeds in real
and/or non dollar denominated assets.
Last
week, the Aggressive Portfolio Sold its holding of Sysco and all our Portfolios
Sold additional shares, leaving the proceeds in cash equivalents.
Thoughts on this earnings season and
all the good times to come (medium):
And:
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 2/28/13 11350 1406
Close this week 14009 1513
Over Valuation vs. 2/28 Close
5% overvalued 11917 1476
10%
overvalued 12485 1546
15%
overvalued 13052 1616
20%
overvalued 13620 1687
25%
overvalued 14187 1757
Under Valuation vs.2/28 Close
5%
undervalued 10782 1335
10%undervalued 10215 1265 15%undervalued 9647 1195
* 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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