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
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 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%
Economics/Politics
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
(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
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
Technical
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.
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