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 13462-14116
Intermediate Uptrend 13398-18398
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 1465-1535
Intermediate
Term Uptrend 1418-2013
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 39%
High
Yield Portfolio 40%
Aggressive
Growth Portfolio 40%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s data was tilted to the negative side: positives---January building
permits and weekly retail sales; negatives---weekly mortgage and purchase
applications, January housing starts, weekly jobless claims and the February
Philly Fed index; neutral---January PPI and CPI ,
January existing home sales and the January leading economic indicators.
However, the real economic news this week
included continued deterioration in the EU economy, the slight change in tone
in the FOMC meeting and the approaching sequester (March 1). I will cover all of these issues in Pluses
and Negatives portion of this narrative.
But in summary: (1) the economic data though mildly negative is typical
of the current recovery and taken by itself is not of concern to me, (2) a
decline in European economic activity can’t be good for our own growth prospects,
though I am not making any changes in our forecast to reflect it---at least for
now, (3) while the reading of the latest FOMC minutes spiked investor blood
pressure Wednesday and Thursday, on Friday Fed officials were all over the
print and TV media reassuring all that the presses will be at full throttle
into the foreseeable future and finally (4) I believe that the sequester will
be a positive for the economy---assuming it occurs, Bottom line: while I am not changing our
outlook, this week’s developments have raised my anxiety level:
‘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
of big four economic indicators:
The pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy.
Counterpoint:
The
negatives:
(1)
a vulnerable global banking system. The big news items this week were the
bankruptcy of the second largest Spanish bank, loan problems in Italy,
Elizabeth Warren taking the too big to fail banks to task and a study on the
unknowable size of the global financial systems exposure to derivatives. I add one more straw on this camel’s back via
the link below:
The latest math on the vulnerability of the too big to fail banks
(medium):
In sum, these all
illuminate [a] the potential risk that exists on any one bank’s balance sheet
and [b] because of the counterparty risk via derivatives becomes a potential
risk on all banks’ balance sheets.
‘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’. Double, bubble, toil and
trouble. March 1 draws nigh and it is
getting hot in the kitchen. The airwaves
are buzzing with a multitude of horrendous, recession inducing consequences if
sequestration is allowed to take effect.
Bulls**t. The reductions in the
rate of spending from the sequester are a wart on elephant’s ass in comparison
to the total spending that will occur even with the sequester. Nevertheless, this dishonest, hyper-rhetoric
will get even worse next week.
The only
question is will the GOP fold or hold firm?
At the moment, it appears that there is
no fallacy, no illusion, no mendacity that Obama will not stoop to in
order to pressure the republicans into folding.
Regrettably, I don’t have a great deal of confidence in the steel in the
GOP’s backbone. So I remain a
skeptic.
As you know, this
is my line in the sand. If republicans
cave; hello European nanny state. Even
if they don’t, it will still be only a baby step in the direction of fiscal
responsibility. It will not solve our
debt and deficit problems; nor will it improve the economic outlook near
term. Only if it is the first of many
steps can we hope to get the debt to GDP
ratio down from 105% to under 90%---which is the threshold postulated by Rogoff
and Reinhart below which a country’s growth is unimpeded by the burdens
associated with too much government debt.
And:
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. The big news this week was the discussion in
the FOMC minutes regarding an end to monetary easing and then two day later
{after a Market hiccup} the very public multiple denials that the Fed will tighten
in our lifetimes.
I had
originally opined that while I didn’t believe the Fed was close to tightening,
the mere mention of it in the FOMC minutes could prompt investors to start
worrying about when it might take place and start hedging their bets in the
bond markets. That could still occur;
but with Friday’s Mission Impossible-like disavowal of
any knowledge of monetary restraint, I suspect this is now a moot
point----leaving investors to return to their prior state of ignorant
bliss.
And leaving the
rest of us with the problem that {i} the Fed has never managed a successful
transition from easy to tight money without causing either a recession or high
inflation and {ii} the longer the Fed pumps, the more difficult that transition
is likely to be.
As you know, my
bet is that tightening won’t happen soon enough; so we get what is behind door
number two: inflation [a] Bernanke has already said {too
many times to count} 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.
Saturday morning humor (two
minute video and a must watch):
Update on inflation (medium):
A corollary concern is that all
this money printing increases the potential for a currency war. ‘ an
overly easy monetary policy generally results in the depreciation of the
currency of that bank’s country which in turn improves that country’s trade
balance and strengthens its economy.
That is great unless its trading partners get pissed and commence their
own ‘easy money/currency depreciation’ effort. At that point, you got yourself a currency
war; and that seems to be the direction that the major economic powers are
headed in.’
[b] a blow up in the Middle East . It was mostly quiet on this front this week---although
the experts are starting to worry that the expansion of the conflict in Mali Nigeria Middle East oil, pushing energy
prices higher.
(4)
finally, the sovereign and bank debt crisis in Europe
remains a major risk to our forecast. This week, we were barraged with a steady
stream of lousy headlines out of the EU: [a] poor PMI
numbers across the continent, [b] a revised European Commission economic
forecast that calls for recession in the eurozone lasting into 2014, [c] a
rapidly expanding Spanish budget deficit [d] a disappointing second round of
LTRO bank repayments and [e] a Moody’s downgrade of the UK credit rating.
Looking ahead
only slightly, the Italian elections occur Sunday and Monday with Berlusconi’s
anti austerity party running in second place.
Any outcome that would lead to a reversal of current fiscal policy could
threaten Italy
Still, investors
refuse to hold the eurocrats to account for their inaction in dealing with the
current sovereign/bank insolvency problems; and hence, they continue to do nothing. As a result, the worsening economic climate
will at the very least impact global activity and at the worse precipitate
another state or financial institution bankruptcy that potentially exposes the
global banking community to another round of counterparty defaults.
And:
Bottom line: the US MSM
are portraying it to be. Indeed, I think
that it could be a positive, if it occurs.
Fed policy is unlikely to change in the next six to nine months, as
affirmed by Friday’s Fed media blitz.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies. The likelihood of those happening has probably
increased as the EU economy slips further into recession (lousy PMI ’s,
Spanish budget deficit, EC forecasts recession into 2014) and political instability
(Italian elections). Of course, nothing
will happen as long as investors maintain their current optimism---which will
not likely go on forever.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
down; January housing starts declined but building permits were up while
existing home sales fell fractionally,
(2)
consumer: weekly retail sales improved; weekly jobless
claims rose more than anticipated,
(3)
industry: the Philly Fed February manufacturing index
plunged,
(4)
macroeconomic: January PPI and CPI
were basically in line with forecasts; January leading economic indicators were
up slightly less than expected.
The Market-Disciplined Investing
Technical
The indices
(DJIA 14000, S&P 1515) finished within both their short term uptrends (13462-14116,
1465-1535) and intermediate term uptrends (13398-18398, 1418-2013). With
Friday’s nice rebound, the Wednesday/Thursday air pocket appears to have had no
lasting impact. I still think it
reasonable that the Averages will challenge 14140/1576.
Volume on Friday
was up and breadth was particularly strong.
The VIX was off but still closed within its intermediate term
downtrend---a positive for stocks.
GLD rose for the
second day, but still could not recover above the lower boundary of its short
term downtrend---not good.
Bottom
line:
(1)
the Averages are trading within their short term
uptrends [13462-14116, 1465-1535] as well as their intermediate term uptrends
[13398-18398, 1418-2013].
(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 (14000)
finished this week about 23.5% above Fair Value (11350) while the S&P (1515)
closed 7.8% 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 .
The economy is
tracking with our forecast; and as I noted above, (1) any Fed tightening is
still a ways off and (2) any spending cuts from sequestration will have minimal
impact on the economy. Hence, there are
no domestic economic reasons to alter the assumptions in our Valuation Model.
That said, there
could be one potential psychological impact:
if our ruling class actually does the right thing, makes substantial
reductions in government spending which would in turn portend a higher future
economic and corporate profit growth rate.
I categorize this as unlikely; so
I am not even considering factoring it into our Valuation Model. I will, however, be watching.
On the other
hand, Europe continues to deteriorate both economically
and politically. If these trends aren’t
reversed, then my guess is that sooner or later our Valuation Model gets
changed as a result of (1) declining US
corporate profits due to the poor performance of European subsidiaries and/or
(2) damage done to the global financial system by sovereign/bank insolvencies.
Unfortunately, the odds of one or both
of the above are something more than unlikely.
As you know, our
forecast is for Europe to ‘muddle through’’ and so far,
that is exactly what it has done.
Regrettably, this scenario is more a function of investors being willing
to believe that the eurocrats can successfully stem any crisis than actual
proof that they can or even know how do so.
To be fair, to date they have held off disaster. However, they have done nothing to fix its
systemic causes---which in point of fact have gotten worse. So the question is, can they do it again when
conditions have further deteriorated? I
don’t know; but I am suggesting that (1) the odds of averting a crisis the next
time are lower than they were on the previous occasion and (2) the tail risks
have grown in magnitude.
My investment conclusion: nothing has happened (data, FOMC minutes,
sequestration) that would warrant a change in the assumptions in our Valuation
Model. Hence, stocks remain
overvalued.
However, the risks of a deeper European
recession/financial debt crisis are rising.
These could effect our profit assumptions in both Models and our P/E
assumptions in our Valuation Model. The
problem is that I still can’t quantify those dangers associated with a severely
wounded financial system.
This week, our Portfolios continued to lighten up on either
fundamentally or technically overextended stocks.
The latest from JP Morgan (medium):
Final readings on this season’s revenue and earnings ‘beat’ rate
(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 2/28/13 11350 1406
Close this week 14000 1515
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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