Wednesday, March 27, 2013

UBS equity strategist

Morning Journal-A primer on derivatives


   This Week’s Data

            The International Council of Shopping Centers reported weekly sales of major retailers fell 1.7% versus the prior week but rose 1.0% versus the comparable period last year; Redbook Research reported month to date retail chain store sales up 2.6% on a year over year basis.

            February durable goods orders were up 5.7% versus expectations of an increase of 3.6%; ex transportation, the number was up 0.5% versus estimates of up 0.7%.

            The January Case Shiller home price index advanced 1.0%, in line with forecasts.

            February new home sales fell 4.6% versus an anticipated drop of 2.7%.

            The March Conference Board consumer confidence index plunged to 59.7 from February’s reading of 69.5.

            The March Richmond Fed’s manufacturing index was reported at 3.0 versus expectations of 5.5.

            Weekly mortgage applications rose 7.7% while purchase applications were up 7.0%.


            The latest from Gary Shilling (medium):

            A primer on the derivatives market (medium and today’s must read):

            Global financial stress rises (short):

            ***overnight, Italian industrial and retail sales came in well below expectations.



Update on the student loan debacle (medium):


The Morning Call--Cyprus: the good, the bad and the ugly

The Morning Call


The Market

            The indices (DJIA 14559, S&P 1563) had a great day.  The Dow finished above its former all time high (14190) and the upper boundary of its short term uptrend (13803-14492) while the S&P closed below its comparable levels (1576) and 1508-1582).    Both remain within their intermediate term uptrends (13588-18588, 1438-2032) and their long term uptrends (4783-17500, 688-1750).

            The important takeaway is that the Averages are still not in sync with the S&P not confirming the Dow’s break out to new highs.  This leaves open the question of whether the Market is topping or pausing before another upward assault.  I continue to believe that (1) stocks are topping, (2) the S&P can still make a challenge of the 1576 level and (3) even if it breaks out to the upside, the reward is less than 10% and the risk is substantial.

            Volume declined; breadth was mixed with the flow of funds and on balance volume indicators weak.  The VIX fell, remaining within its short and intermediate term downtrends.

            GLD was down, staying within its short term downtrend.  However, the developing support level continues in tact.

Bottom line: as frustrating as it may be, the indices remain out of sync; and hence, Market direction is in question. 

            The historical performance of stocks in April (short):

            Here is a positive technical indicator (short):


            Lots of stats yesterday; and unfortunately, they were not all that great.  Durable goods orders were the bright spot while weekly retail sales, January home prices, February new home sales, consumer confidence and the Richmond Fed manufacturing index all fell short of expectations. This is really the first bad data day in a long time; so I see no reason to get concerned.

            Cyprus remained the media focus, as pundit after pundit weighed in on the terms of the bail out.

            This is a great piece on the good, the bad and the ugly of the Cyprus solution (medium and a must read):

            Nobody in the EU (except the Germans) is happy with the Cyprus bail out, especially the capital controls:

            The Cypriot youth:

                The French and Spanish:

            The Brits:

But as hinted to in an earlier link, the Russians seem to be fine.  They snuck out the back door (medium):

            Cyprus has already left the eurozone (short):

            Satyajit Das on Cyprus (medium):

            Cyprus template being framed into law (medium):

            Spain sinks further into the abyss (medium):

            The problem with the euro in one short, easy lesson (short):

            Bottom line: as dismal as much of the above reading is, US investors were clearly upbeat.  Part of that optimism is understandable: (1) the uncertainty over depositor insurance and capital controls will likely drive money to the US and (2) as long as the EU financial system is in a state of flux, the Fed is apt to keep the pedal to the metal.

As I indicated yesterday, I am also encouraged but for somewhat different reasons---though I do  agree that foreign money inflow can be a positive.  I am positive because the eurocrats have finally taken steps that are half way sensible, i.e. holding risk takers versus taxpayers responsible for bank defaults. (***in fact, if the US had handled its financial crisis using the Cyprus template, we would have a sounder banking system than we do now.)  To be sure, it is not all perfect (capital controls, not forcing the banks to go through bankruptcy court); but it is a major step in the right direction.

Yes, there is going to be pain that likely extends far beyond Cyprus.  But there was going to be pain anyway, sooner or later.  In my opinion, anyone who assumed that after years of totally irresponsible fiscal policies that somehow the EU ‘muddling through’ scenario would not involve some pain, at times severe, is suffering from an acute case of naiveté. 

So I guess where I part company with those who were pumping up stock prices yesterday is that I believe (assuming the EU/ECB doesn’t slap another monetary band aid over the next sovereign/bank problem but uses the Cyprus template) that the pain will come near term.  True that will mean flows into the dollar which will be a positive.  But there will still likely be heartburn sufficient enough to sound the derivative counterparty alarms.  Plus Europe will continue to deteriorate economically and that is not going to help the profits of US companies.  I don’t believe that this combination of events will play well in an overvalued US stock market.

            AAII asset allocation (short):

            The latest from Nomura (short/medium):

            The latest from Lance Roberts (medium):
            Pension fund rebalancing could be a problem for stocks (medium):

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. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.

Tuesday, March 26, 2013

The latest from Art Cashin

Teva Pharmaceuticals (TEVA) 2013 Review

Teva Pharmaceutical Industries is an Israeli based global pharmaceutical company that develops, manufactures and markets generic and proprietary branded drugs and active pharmaceutical ingredients.  The company has grown profits and dividends at a 25%+ rate over the last ten years earning a 14-20% return on equity.  The company was little impacted by the recent recession and should continue to expand as a result of:

(1) plentiful growth opportunities in generic drugs.  The company currently has 83 product applications pending before the FDA,

(2) a significant and growing branded pharmaceutical business,

(3) the company has a very successful at resolving patent challenges which is a key part of generic product selections and development strategy,

(4) it is pursuing strategic relationships,

(5) a major R&D effort in the biopharmaceutical and biogeneric markets.

(6) significant cost reduction program.


(1) the pharmaceutical industry is very competitive and the generic segment is highly crowded,

(2) gaining approval for drugs is becoming more difficult in an increasingly tough regulatory environment,

(3) weak sales in the EU.

TEVA is rated A by Value Line, has a 36% debt to equity ratio and its stock yields 2.9%.

 Statistical Summary

                 Stock        Dividend         Payout      # Increases  
                 Yield      Growth Rate     Ratio        Since 2003

TEVA        2.9%          13%               22%              10
Ind Ave      3.8              6*                 46                NA 

                  Debt/                       EPS Down       Net        Value Line
                 Equity         ROE      Since 2003      Margin       Rating

TEVA        36%           17%            0                 22             A
Ind Ave      27              18              NA              15            NA

*many companies in TEVA industry do not pay a dividend

            Note: TEVA stock has performed poorly since its October 2008 low.  While it has managed to trade above the downtrend off its March 2008 high (red line), it is just barely above it currently.  Similarly, the stock struggled several times with the November 2008 trading high (green line) and today trades below that level.  Long term, the stock is in a trading range (straight blue lines).  Intermediate term, it is a downtrend (purple lines).  The wiggly blue line is on balance volume.  The Aggressive Growth Portfolio owns a 70% position in TEVA.  The upper boundary of its Buy Value Range is $36; the lower boundary of its Sell Half Range is $67.     


More on Cyprus

Larry McDonald makes a great point---even though the losers in the Cyprus are the risk takers, rightfully so, the politicians are the ones making those decisions not the bankruptcy courts.  And that is not positive for investor confidence.

Morning Journal--The American Oligarchy


   This Week’s Data

            The February Chicago Fed National Activity Index came in at .44, up from the prior reading of -.49.

            The March Dallas Fed manufacturing index was reported at 7.4 versus expectation of 3.4.


            The case for optimism (medium):



The American oligarchy (medium):


            In Japan, things keep getting nuttier (short):

The Morning Call--Cyprus, it's confusing

The Morning Call


The Market

            The DJIA (14447) traded back below the upper boundary of its short term uptrend (13791-14485) yesterday; though it remains well above the former all time high (14190).  Meanwhile, the S&P (1551) continued to trade below both the upper boundary of its short term uptrend (1505-1579) and its prior all time high (1576).  

The return of the Dow to the boundaries of its short term uptrend is not that significant; although that it is a sign of some loss in the Dow’s upward momentum.  The more important point is that the S&P still can’t challenge its all time high and, therefore, it is not confirming the DJIA’s breakout. 

That leaves the $64,000 question unanswered: is the Market in a topping process or resting for another move up?   As you know, I lean to the former but I am not overly worried about being wrong because I just don’t see the upside from either the technical or fundamental standpoint.

Volume rose slightly; breadth was weak with on balance volume particularly so.  The VIX increased though much less than I would have thought on a day such as yesterday.

GLD was down, finishing within its short term downtrend but below the lower boundary of that developing very short term uptrend---suggesting that we need to remain cautious.

Bottom line: the indices remain in a condition of nonconfirmation; and until that gets resolved, there is not much more to say regarding Market direction.  Nevertheless, how this gets resolved is important because if we are in a topping process, then investor emphasis will shift from chasing performance to preserving capital.

            Why the pain trade is higher (short):

            The last four trading days of March (short):

            The S&P and the 200 day moving average (medium):

            First quarter 2013 versus first quarter 2012 (short):


            We got two solid pieces of economic data yesterday: the Chicago national activity index was up versus estimates of a decline and the Dallas Fed manufacturing index came in better than anticipated.  So far, the US has escaped any contagion from Europe; and that is a positive.

            Speaking of which, Cyprus continued to dominate the headlines.  As trading began yesterday, hopes were up based on the approved bail out of the Cypriot banks over the weekend.  As I noted in Monday’s Morning Call, I thought that the terms were better than anything I had expected; to wit, the bank reorganizations actually were executed as they should be, if the rule of law is followed---shareholders got wiped out, then the junior creditors, then the senior creditors, then the uninsured deposit holders. 

That was completely out of character since the ECB in its infinite wisdom had previously tried a polyglot of alternative measures as it dealt with Ireland, Greece, Portugal, Spain and Italy sovereign/bank insolvencies.  Unfortunately, the bottom line for most of those bail outs: bank balance sheets were left relatively untouched, severely compromised assets (sovereign and real estate debt) remained, carried at or near par value with no haircuts applied to shareholder equity, creditors and uninsured depositors while operating loses were covered by the ECB or taxpayers---exactly the opposite of what is supposed to happen in a bankruptcy. 

Suddenly in Cyprus, the guys that took the risk (equity and debt holders) are now suffering the consequences.  To which I say hallelujah.  The only way the EU financial system returns to health is cleaning the bank balance sheets of worthless loans and paying for it with the assets of risk investors.

The catch here is this bail out was sold by the eurocrats as a one off solution because in Cyprus’ case so much of the risk capital (large uninsured deposits) was supplied by those evil, tax dodging, money laundering, Russian oligarchs. 

Then the Dutch finance minister made a mistake.  He told the truth, i.e. Cyprus would be a template for future EU bank insolvencies.  Ooops.

His initial statement; later recanted (medium):


            But the damage was done.  Now everyone with a large (i.e. uninsured) deposit in another leveraged eurobank was going hummmmmm, what should I do now?  And visions of bank runs danced in their heads (medium):

            In the meantime, the Russians may have already gotten their money out of Cyprus; in which case, the remaining large depositors are totally f**ked.

            Thoughts from Wall Street strategists (medium):

            Thoughts from the former governor of the Cypriot central bank (medium):

            What happens when the Russians leave (medium):

            The euro’s ‘poverty effect’ (short):

            Adding to the confusion created by Cyprus template/recantation comments, no one seems to know when the banks are going to open again---and that’s a problem.

And remember when the banks do open, capital controls will be in place---something else that scares depositors throughout the EU.

Bottom line: I made the point last week that how the Cyprus bail out was conducted was more important than the bail out itself.  As I noted above, the ‘how’ was better than anything I could have expected, i.e. at long last the eurocrats actually applied the rules as they were originally designed and written.  The plan as applied to Cyprus is, in my opinion, the best path to a sounder EU banking system and a return to growth---assuming that this will be the template for future actions. 

That said, (1) it is not perfect.  Capital controls will negatively impact depositors in other EU countries and (2) any cure for a malignant cancer is going to be painful; and that pain---the rebalancing and cleaning up on bank balance sheets throughout the EU---is what  weighed on the Market yesterday.

I am fine with the latter.  The pain needs to be administered and economies set on a sounder course; and if that means (1) tough economic times---that is the price you  pay for years of  profligacy and mismanagement and (2) lower stock prices, so what.  Stocks are currently overvalued (at least by our Model).  Indeed, one way to raise valuations to current nominal levels is to improve the long term secular economic global growth prospects.  The Cyprus bail out template is a first step for the EU in that direction.

I caution that if Cyprus does become the template, then our short term ‘muddling through’ scenario may become a bit more rocky while the long term ‘tail risk’ of an EU collapse lessens.  I can handle a tougher short term economic outlook because that is more easily quantifiable than trying to deal a situation where a crisis is almost certain, but I don’t have a clue as to when it occurs or how dire the consequences.

So while a Cyprus template for the rest of the EU may cause some heartburn short term, it would be a significant positive long term.

All that said, the eurocrats could chicken out of the Cyprus template scenario and go back to their old ways.  In which case, ignore everything I just said.

            Meanwhile, keeping the banks closed and providing no guidance as to when they will open is a problem that will only get worse the longer it is drug out.

            The latest from John Hussman (medium):

            The sunk cost fallacy (short):

            What are bond investors thinking (medium):

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. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.

Monday, March 25, 2013

Monday Morning Chartology

The Morning Call


The Market

      Monday Morning Chartology

The S&P remains in an uptrend in all three time cycles.  On the other hand, it has yet to confirm the Dow’s move above its previous all time high.

 GLD seems to be acting a bit better.  It continues to trade near the mid point of its short term downtrend.  A short term support level and a very short term uptrend continue to develop.  Note the improvement in on balance volume (wiggly blue line).


The VIX remains in its short and intermediate term downtrends.

            Update on ‘the best stock market indicator ever’:

            Over the weekend, Cyprus and the EU came up with a bail out plan in which two large Cypriot banks will be restructured with the junior and senior creditors taking a hit (this is a positive because the rule of law has triumphed) along with depositors not covered by deposit insurance.

            All in all a decent solution as long as you are not a junior/senior creditor or a large depositor or a bank employee that will lose his/her job.  Since the Russians fall in the large depositor category (rumors are the ‘hit’ will be from 40% to 100% of their deposits), we are not yet at the final act.

            Here is Goldman’s take (medium):

            There was also some pain in Spain (medium):

            More on valuation (short):


      News on Stocks in Our Portfolios courtesy of Seeking Alpha
Tiffany & Co (TIF): Q4 EPS of $1.40 beats by $0.04. Revenue of $1.2B (+4% Y/Y) misses by $0.05B.

Nike (NKE):
 FQ1 EPS of $0.73 beats by $0.05. Revenue of $6.2B (+9% Y/Y) misses by $0.04B.


   This Week’s Data




Thought for the day (short):

  International War Against Radical Islam

            Fast pass for Saudi Arabia (medium):

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. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.

Saturday, March 23, 2013

Thoughts on Investing

Thoughts on Investing--from Ivanhoff

20 Truths About the Stock Market

1. Stock prices run in cycles. Periods of re-pricing are usually quick and powerful and then they are followed by trendless consolidation.

2. Stocks are very highly correlated during drastic sell offs and during the initial stage of the recovery. In general, correlation is high during bear markets.

3. Bull markets are markets of stocks, where there are both winners and losers. When the market averages consolidate, there are stocks that will break up or down, revealing the future intentions of institutional buyers.

4. In the first and last stage of a new bull market, the best performers are small cap, low float, low-priced stocks.

5. Try to trade in the direction of the trend. It is not only the path of least resistance, but also provides the best profit opportunities. Have a simple method to define the direction of the trend.

6. Traders’ attention (and market volume) is attracted by unusual price moves. Sudden price range expansion from a consolidation is often the beginning of a powerful new trend.

7. Opportunity cost matters a lot. Be in stocks that move. Stocks in a range are dead money.

8. Big winners are obvious only in hindsight. Many other stocks shared the same characteristics when they tried to break out. Some failed. Some had a follow through. Being wrong is not a choice. Staying wrong is. You can only control your risk and how long you will ride your winners.

9. The overall market conditions will never be perfect and when they seem so, it is probably a good idea to decrease exposure and take profits. With that in mind, you don’t have to be in the market all the time. When you don’t see good setups, it just makes sense to watch from the sidelines.

10. Big institutions achieve outsized returns by riding strong trends for the long-term (long enough to make a difference). This is the only way for them. They can’t easily and often get in and out due to their size. Establishing small positions does not make sense for them as it would not make a difference for the bottom line. Big winners can make a difference when they are big positions. Big positions take time to accumulate and along the way institutions leave clear traces.

11. Small losses are often better than small gains. If I sell my position every time it shows me a small gain, I would never achieve a return high enough to make a difference and to cover the inevitable losses. Amateurs go bankrupt by not taking small losses. Professionals go bankrupt by taking small gains. It is absolutely true that a large number of consecutive gains could multiply returns substantially. The point is how big should be those gains. 4-5% is not going to help a lot. 15-20%  gains is something completely different.

12. Prices change when expectations change, but sometimes expectations change when prices change. In other words, there are different types of catalysts that move stocks. In long-term perspective (years), stocks move based on the underlying social trend and the stage of the economic and liquidity cycle. In medium-term perspective (months), stocks move based on expectations for earnings and sales growth. In short-term perspective (weeks and days), stocks move based on price action primarily.

13. If you understand the incentives of the major market participants, you will be able to predict their likely behavior. Technical analysis is a lot about understanding incentives and recognizing intentions.

14. Your first loss will often be your best loss. No one is right all the time and you don’t have to be. There are market participants that are immensely profitable by being right only 30% of the time. It is good to have conviction in your investment thesis, but discipline should always trump conviction.

15. Optimism and pessimism in the stock market are contagious. Investors’ psychology often loses its logic and become emotional. The news media and the most recent price action play a particularly important role in developing moods of mass optimism or pessimism.

16. Declining stocks often reverse their downtrends near the end of the year, as selling for income tax purposes subsides.

17. Fair value is an illusive concept and hard to calculate. While it is true that you don’t need to know the exact weight of a person to define if he is overweight, applying this philosophy is not going to help you in the stock market. Stocks constantly get overvalued and undervalued. This is the nature of the market. Warren Buffett says that price is what you pay, value is what you get.  I believe that value is what you think you get, price is what other people are willing to pay for it.  Just as beauty, value is in the eyes of the beholder. (there are universally accepted measures too, of course)

18. Liquidity is cyclical. It constantly expands and contracts. When it contracts, capital flows to perceived safety – U.S. Dollars and Treasuries.

19. Rising P/E is an indicator of rising expectations and confidence in the future of the stock. The P/E ratio reflects the enthusiastic optimism or the gloomy pessimism of investors.

20. When you calculate the time you need to drive from point A to point B, you should always take traffic into account.  Traffic is like the stock market. You might pretend that it doesn’t matter, but it will impact you anyway. It doesn’t matter how smart you are, how ingenious your idea is or how cheap your stock is – if the market does not agree with you, you will not get paid. Period.

The Closing Bell--3/23/13

The Closing Bell


Note: our daughter gets married next weekend.  Mother and daughter have more  errands, tasks etc for me to accomplish than is humanly possible.  So Wednesday morning’s Morning Call will be the last communication till next Monday or Tuesday.

Statistical Summary

   Current Economic Forecast


Real Growth in Gross Domestic Product:                      +1.0- +2.0%
                        Inflation (revised):                                                             2.5-3.5 %
Growth in Corporate Profits:                                 5-10%


                        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                                13773-14462
Intermediate Uptrend                              13565-18565
Long Term Trading Range                       4783-17500
                        2012    Year End Fair Value                                     11290-11310

                        2013    Year End Fair Value                                     11590-11610                                          

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                       1504-1578
                                    Intermediate Term Uptrend                       1436-2030 
                                    Long Term Trading Range                        688-1750
                        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                                        42%
            Aggressive Growth Portfolio                           40%

The economy is a modest positive for Your Money.   It was a slightly below  average week for economic data flow but the numbers were generally upbeat: positives---February building permits, weekly retail sales, the March Philly Fed index and February leading economic indicators; negatives---weekly mortgage and purchase applications; neutral---February new and existing home sales, weekly jobless claims and the most recent FOMC decision to leave policy unchanged.

 I remain encouraged by our improving economy albeit at a sub par rate..  Hence the outlook 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 pluses:

(1) our improving energy picture.  The US is awash in cheap, clean burning natural gas.... In addition to making home heating more affordable, low cost, abundant energy serves to draw those manufacturers back to the US who are facing rising foreign labor costs and relying on energy resources that carry negative political risks. 
(2) an improving Chinese economy. This week, Chinese PMI came in better than expected, keeping alive the hope that the economic strength there will offset a deteriorating Europe.

       The negatives:

(1)   a vulnerable global banking system.  The latest outrage is a series of bills offered in congress supporting the continuing strategy of the banksters to take a lot of risk, pay bonuses when it works and let the public pick up the tab when it doesn’t (medium):

‘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’ [fiscal policy].  More good news this week.  Drum roll.........the senate actually passed a continuing resolution and the house followed suit removing another ‘drop dead’ date from the proximate future.  That doesn’t mean the problems of too much spending and too many taxes have been solved.  But it does buy time for negotiations in a less emotionally charged, time weighted atmosphere. 

We still don’t know if the recent Obama charm offensive is for real or simply another of His politically cynical ploys.  However, as I have said, if He means it and that results in a path to a more fiscally responsible budget, then this would be a major positive and shift fiscal policy from a negative to a positive in our outlook. 

    That said, the senate rolled out its first budget in four years.  It included the elimination of the spending cuts in the sequester and the addition of more taxes.   I am sure [hope?] that this just a negotiating stance; although clearly there is a long way to go to get to ‘a more fiscally responsible budget’.  Hence, my hesitancy to get jiggy at this moment.

However, we still have a problem ...... the potential rise in interest rates and  its impact on the fiscal budget.  As I have noted previously, the US government’s debt has grown to such a size that its interest cost is now a major budget line item---and that is with rates at/near historic lows.  Moreover, government debt continues to increase and the lion’s share of this new debt is being bought by the Fed. 

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.....
(3)   rising inflation:

[a] the potential negative impact of central bank money printing.    This week an official of the Bank of Japan advocated an even easier monetary policy for that country than already exists.  And at home the FOMC met and left interest rates and QE in place.

As you know, I don’t believe that the current massive injection of liquidity is going to end well; and the longer it goes on, the worse that outcome will be.

Of the twin evils {recession, inflation} that come with the irresponsible expansion of monetary policy, my bet is that tightening won’t happen soon enough; so the US economy will sooner or later face soaring 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.
      A corollary concern is that all this money printing increases the potential for a currency war {i.e. this week’s Chinese reaction}.  ‘ 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.  The concern remains that violence could erupt in any of the many flash points in the region and that would in turn lead to a disruption in either the production or transportation of Middle East oil, pushing energy prices higher.
(4)   finally, the sovereign and bank debt crisis in Europe remains a major [?] risk  to our forecast.  As you know, this problem wormed its way back into investor consciousness this week---with Cyprus as the flash point.  Its banks have assets eight times its GDP and are insolvent.  The ECB agreed to a bail out with the condition that Cyprus put up a portion of the funds [E5.8 billion;  oops, it is now E6.7 billion]. 

The initial solution that was proposed had several problems: [a] insured deposits were to be ‘taxed’ to get a portion of the E5.8 billion---in other words, confiscation and [b] the entire burden fell on depositors while the senior creditors {largely EU banks} were left whole. 

But not to worry, because the Cypriot parliament rejected the plan.  It then proposed Plan B [Russian bail out], that was nixed; then Plan C [‘good’ bank, ‘bad’ bank plus nationalizing state pension plans], that didn’t work; then the ECB set Monday as a deadline and upped the amount Cyprus needed to contribute [E5.8 billion to E6.7 billion]

As this is being written, this situation is changing faster than a runway model, but we are getting the some of the elements of Plan D---so far there is [a] a plan to restructure the banks and [b] capital controls.  We don’t know yet about deposit ‘taxes’ and where the senior lenders stand in the restructuring process.

To be clear, it doesn’t strictly matter what happens to Cyprus because its problems are too small to have an impact on the EU much less the global economy.

However, what could be important is how the crisis is resolved.  Any solution  that: (1) damages the credibility of the eurocrats to manage the EU sovereign/bank debt crisis (2) impairs depositor confidence in their home country banks, (3) triggers counterparty risk on Cyprus debt or (4) creates potential political conflict between Russia and the EU may likely have ramifications beyond simply an extremely small island nation going toes up---I will further deal with this point in the Fundamental section.

Who is next?( medium):

       And (medium):

Bottom line:  the US economy remains a plus for Your Money.  Fiscal policy may be in transition right now with some probability that our elected reps will do the right thing, put the budget on a more sustainable path and turn an economic negative into a positive.  However, I am not altering our Economic Model nor making any bets on the assumption that this will take place.

Meanwhile, the Fed policy seems headed to a 2000 or 2007 like end game.  I am not smart enough to know when conditions will start to unravel or the magnitude of the fall out when they do.  When it does, I will likely have to alter our Model.

Finally, the eurocrats are no closer to resolving the multiple European sovereign/bank insolvencies than they were a year ago.  Nothing could make this point more obvious than the Cyprus bail out in which they (1) have proposed and had rejected three solutions and are now working on a fourth plan and (2) it appears that Plan D will contain capital controls, deposit taxes and subordination of depositors to senior lenders---are of which are violations of current EU rules and regulations.

Of course, Cyprus has a very small GDP and, therefore, any dislocations in the Cyprus economy resulting from the bail out/bankruptcy/resolution is unlikely to impact the EU economy, much less our own.  However, an EU wide loss of investor/voter confidence stemming from that resolution could negatively influence the European economy with spill over effects in our own---though I am not yet ready to change our Model to reflect this.

Interview with the president of the Bundesbank (long):

Fitch puts UK on negative watch list (medium):

This week’s data:

(1)                                  housing: weekly mortgage and purchase applications fell; February new home sales were up but less than anticipated though building permits were strong; February existing home sales rose but less than estimates,

(2)                                  consumer: weekly retail sales improved; weekly jobless claims rose but less than expected,

(3)                                  industry: the March Philly Fed index came in much better than forecasts,      
(4)                                  macroeconomic: the FOMC believes economic conditions have improved marginally and left policy unchanged; February leading economic indicators increased more than anticipated.

The Market-Disciplined Investing

The DJIA (14512) remains above its previous all time high (14190); and, after a one day retreat below the upper boundary of its short term uptrend  (13773-14462), it ended the week back above that boundary.  It closed within its intermediate term uptrend (13565-18565) and its long term uptrend (4783-17500). 

The S&P (1560) finished below its previous all time high (1576) and the upper boundary of its short term uptrend (1504-1578).  It is also within its intermediate term uptrend (1436-2030) and its long term uptrend (688-1750).

So for the third week, the Averages remain out of sync and the break out to new highs by the Dow is not confirmed.  That keeps open the question as to whether we are witnessing a topping process or a consolidation in preparation for a launch higher. Whichever occurs, the technical guideline is that the longer this process goes on, the more volatile the directional break when it finally happens.  As you know, I favor a move to the downside.  But I am not overly concerned if I am wrong because I don’t believe the risk/reward is that attractive otherwise. 
Volume was anemic; breadth improved.  The VIX was down modestly; and so it remains in both a short term and intermediate term downtrend---a positive for stocks.

GLD fell but remained in its short term downtrend.  It continues to develop a  support level as well as a very short term uptrend.
            Bottom line:

(1)   the S&P is trading within its short term uptrend [1504-1578] while the Dow finished above the upper boundary of its short term uptrend [13773-14462].  They both closed within their intermediate term uptrends [13565-18565, 1436-2030].

(2) long term, the Averages are in a very long term [80 years] uptrend defined by the 4873-17500, 688-1750. 
   Fundamental-A Dividend Growth Investment Strategy

The DJIA (14512) finished this week about 27.8% above Fair Value (11350) while the S&P (1556) closed 10.6% overvalued (1406).  Incorporated in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal policy under control, 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. 

The ruling class continues to honor a cease fire as Obama schmoozes the GOP.  Plus congress, with a total absence of rancor, has passed a continuing resolution.  That doesn’t mean that ideological rigor won’t reassert itself as negotiations continue on a budget deal---witness the initial senate plan.  But there is still room for hope. 

The object here is lower the government’s usurpation of private capital and resources by putting fiscal policy on a path that will lead to a lower deficit as a percent of government spending and lower government spending as a percent of GDP---these being two of the primary causes of our sub par secular economic growth.  Of course, it is much too early to assume our elected representatives will actually do the right thing.  But were it to occur, it would certainly have a positive impact on our Valuation Model via a rising long term corporate profit growth rate and a lower discount factor (higher P/E’s).

On the other hand, nothing can deter the Fed from its drive to deforest America.  I acknowledge the point of the deflation advocates that argue that as long as the country is deleveraging, all those reserves piled on bank balance sheets remain largely sterilized.  However, we know that while the banks aren’t lending much money, their trading desks are using at least a portion of those reserves to fund highly risky investments (see JP Morgan/London whale and below).  Furthermore, that argument fails to deal with the ‘when’ factor; that is, when the country ceases to delever, then those reserves could become more high powered and we will be faced with the same history---the Fed has never successfully transitioned monetary policy from too easy to too tight.

Here is where the risk exists on bank balance sheets (medium and a must read):

As you know, I have built a  rising rate of inflation into our Economic Model and adjusted the future discount factor in our Valuation Model.  I may be a bit early if the deflationistas are correct; but I am leaving those assumptions alone because we have never been in these uncharted waters of monetary expansion before.  Indeed, with all the money sloshing around the global banking system, I may be underestimating the potential inflationary damage. 

Moving on the Europe---while I am pleased that our ‘muddle through’ scenario continues to hold in the face of degenerating economic, social and political conditions and weakening bank balance sheets, the more conditions deteriorate, the more my concern has grown that our forecast is too optimistic---and of course, the latest mess in Cyprus only crystallizes that point.

However, to be clear---the Cypriot government and/or banks going bankrupt are not my worry.  In fact, (1) an EU bankruptcy is long overdue and (2) if it happens, it will likely drive investors to  US markets.  What I fret about is how casually the rule of law has been  ignored in this bail out. 

At this writing, the Cypriot parliament is in the process of passing a series of laws (Plan D).  So far they have created a ‘good’ bank/’bad’ bank (though we don’t know the exact terms, especially as they will apply to senior [bank] lenders) and imposed capital controls (illegal).  Yet to be voted on is the depositor ‘haircuts’ (illegal). (Note: Spain just announced a 2% ‘tax’ on bank deposits.)

That said, I am really perplexed that no matter how dire the circumstances and no matter how unsavory the eurocrats’ temporary fixes, the electorates and investors have taken it all in stride---the Cyprus situation being the latest example.    Here we are with regulations either being violated or likely about to be violated---and the markets are basically flat for the week with the great unwashed masses of Europe seemingly oblivious to the fact that capital controls have been enacted and to the risk of  their own bank accounts being at least partially impounded by the ruling class. 

I linked to an article this week which attempted to deal with this muted response of markets and electorates to the continuing worsening conditions in the EU.  Its main thesis was that Europeans are simply resolved to their fate and no matter how difficult conditions get, they believe the eurocrats are doing the best that they can and will accept  the consequences (did anyone say Neville Chamberlain?). 

The author may or may not be right; but whatever is happening, I feel completely out of touch.  In an investment sense, I suppose I should be pleased because my ‘muddling through’ assumption has worked out better than I could have ever hoped.  Indeed, if investors and electorates react as tamely to capital controls, deposit ‘taxes’ and their subordination to the banking class as they have to prior inequities imposed by the eurocrats, then ‘muddle through’ will remain the default scenario right up to the point  where the entire electorate is led to the gas chambers---which from an investment strategy standpoint means the ‘tail risk’ that I have been worried about is less immediate than I thought.

I honestly don’t know what to make of this.  So at the moment, I am just mumbling to myself, wondering what the f**k these guys are thinking about.  Let’s see how Europe deals next week with the reality of capital controls, deposit taxes and the super majority rights of the banksters.  Perhaps I will receive some clarity.

My investment conclusion:  the economic assumptions in our Valuation Model are unchanged.  The fiscal policy assumptions are also unchanged but there is some hope of an improvement---it is simply too soon to tell.  The monetary policy assumptions are also unaltered.  However, it seems certain that they will change and not for the better.

       I am taking a timeout on the EU recession/financial debt problems.  Not because they aren’t happening, but because the Europeans don’t seem to care---and you can’t have crisis if no one thinks that there is one and everyone is willing to accept the consequences their misguided leaders’ actions.  I need to think about this some more.
      This week, our Portfolios did nothing.   I remain concerned enough about monetary policy and the goings on in Europe that I am not bothered by our Portfolios’ above average cash positions.

       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 3/31/13                                   11375                                                  1409
Close this week                                                14512                                                  1556

Over Valuation vs. 3/31 Close
              5% overvalued                                 11943                                                    1479
            10% overvalued                                 12512                                                   1549 
            15% overvalued                             13081                                             1620
            20% overvalued                                 13650                                                    1690   
            25% overvalued                                   14218                                                  1761   
            30% overvalued                                   14787                                                  1831
Under Valuation vs.3/31 Close
            5% undervalued                             10806                                                      1338
10%undervalued                                  10237                                                  1268   
15%undervalued                             9668                                                    1197

* 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 economy not the near term   cyclical influences.  The model is now accounting for somewhat below average secular growth for the next 3 to 5 years with somewhat higher inflation. 

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.