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 13621-14292
Intermediate Uptrend 13468-18468
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 1484-1555
Intermediate
Term Uptrend 1427-2021
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 40%
Aggressive
Growth Portfolio 40%
Economics/Politics
The
economy is a modest positive for Your Money. It was
an average week for economic data flow; and what we got was generally upbeat
especially the employment numbers: positives---weekly mortgage and purchase
applications, weekly retail sales, February retail sales, weekly jobless
claims, February nonfarm payrolls, the ADP
private payroll report and the February ISM nonmanufacturing index;
negatives---January factory orders, the January trade deficit, January
wholesale inventory/sales ratio and fourth quarter productivity and unit labor
costs; neutral---the latest Fed Beige Book.
There is nothing in these stats that raises
concern about our forecast; indeed, a week of data like this is quite
comforting. 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.’
Update
on the big four indicators (medium):
The
pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy. The sole stat out of China
this week was its reported trade surplus which was larger than expected.
The
negatives:
(1)
a vulnerable global banking system. This week’s jewels were [a] a study which I
linked to that showed endemic fraud among the most prestigious banks and [b] a
statement by Attorney General Holder that the DOJ was hesitant to prosecute the
large banks for fear of creating a financial crisis:
.
I am not an
Elizabeth Warren fan; but if she keeps this up, I may contribute to her next
campaign (medium and a must read):
All this emphasizes
the points that [a] a potential risk exists on any one bank’s balance sheet and
[b] because of the counterparty risk via derivatives, it becomes a potential
risk on all banks’ balance sheets.
That said, 17 out of 18 large banks passed the
latest ‘stress test’; so we can’t be dismissive of some improvement taking
place.
‘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’. Another week and all the
hysterical warnings of eminent disaster haven’t yet occurred---except for the
unbelievably sophomoric moves by homeland security to release from custody
illegal aliens scheduled for deportation and the White House to stop guided
tours. To the contrary, the economic
data from the real world has fairly positive.
Hopefully that will bolster republican will to stand firm on fiscal
responsibility in the upcoming continuing resolution negotiations.
Speaking of
which, in a stunning about face, Obama started an outreach program, courting
republicans at White House dinners in an attempt [He says] to reach some kind
of grand bargain---which if it happens would be an enormous long term positive
for the economy. That said the cynic in
me says that Obama is too ideological to ever come to a compromise that would
drive federal spending to a lower percentage of GDP . So I am not yet tip toeing through the
tulips. But if it happens, our long term
outlook would improve considerably and I would likely remove this factor from
the list of negatives.
On a shorter
term basis, the issue remains how much will sequestration and any subsequent spending
reductions impact our economic growth.
As I noted above, thus far it has been minimal; though to be fair, it is
still early. Nonetheless, I maintain my
position that the more money that gets left in Americans’ pockets versus
inefficiently spent by the government is a positive.
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. Nothing new here. Easing continues a pace with the Japanese in
the lead. Somewhat worrisome was a
warning from the Chinese this week to cut that s**t out. Whether or not they really meant it or, more
importantly, will actually do something to counteract it, we don’t know. But if they try, it could raise the blood
pressure of a number of central bankers.
Meanwhile, back
in the good ol’ US of A, the Fed has its steam shovel working 24/7 digging a
hole from which, I believe, it can not extract itself without considerable
damage. As I have pointed out all too
often, the Fed has historically proven inept in managing the transition from
easy to tight monetary policy---either either tightening too soon and pushing
the economy into recession or waiting until it’s too late and spurring
inflation.
As you know, 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.
The Fed balance sheet; it’s
scary (must read):
Too much central bank easing
is becoming dangerous (medium):
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 . Not much new this week other than Kerry
promising $250 million in aid to Egypt ---the
sequester holocaust notwithstanding.
The concern
remains that violence could erupt there or in any of the other numerous flash
points which 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. This week, economic conditions continued to
deteriorate as datapoint after datapoint tracked weakness across the
continent. In addition, Spanish PM
Rajoy’s scandal problems got worse and Fitch downgraded Italian debt.
Nonetheless,
investor insist on trying to make a silk purse out of a sow’s ear; and the
eurocrats are only too happy to use these moments of euphoria to do nothing to
correct the sovereign/bank insolvency problems.
As a result, the risks mount that
a sick EU will, at a minimum, be a drag on global growth and could potentially
precipitate a sovereign or financial institution bankruptcy that would expose
the world banking community to another round of counterparty defaults.
Bottom line: the US
economy remains a plus for Your Money. So
far, the sequester has come in like a lamb; and as an even bigger bonus, Obama
is at least talking with republicans about trying to reach a grand bargain on
the budget. While I am highly doubtful
that it will happen, no one would be happier if it did; and if it does, that
will have a positive long term impact on
our Economic Model.
On the other
hand, I believe that Fed policy is a disaster that only gets worse with each
month and additional $85 billion.
Virtually everyone agrees that when the music stops, there will be hell
to pay. Forecasting when that occurs and
the degree of pain that will be experienced has become a parlor game among the
pundits and chattering class---with everyone assuming that he is the smartest
swinging Richard in the group and will therefore be first to know and
react. To which I say, good f**kin’ luck---‘cause
there is only one first out of the door.
The plebeians
are left with a choice between a recession and inflation; and the tail risk of
each grows with every passing day and dollar.
As you know, given Fed history, I think that our poison will be
inflation---some of which is already in our Economic Model. However, depending on timing, I may have to
revise upward our inflation expectations.
The other major
risk to our Models remains multiple European sovereign/bank insolvencies. The likelihood of that happening is probably
increasing as the EU economy slips further into recession and the eurocrats do
their best imitation of an ostrich. That
said, ‘muddle through’ is the operative scenario until either one or more
electorates or the Markets hold the ruling class to account.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications soared,
(2)
consumer: weekly retail sales improved again and
February retail sales advance modestly; weekly jobless claims declined versus
expectations for an increase, February nonfarm payrolls were a blow out and the
ADP private payroll report was slightly
better than forecast,
(3)
industry: the February ISM nonmanufacturing index came
in better than anticipated; January factory orders were disappointing; January
wholesale inventories soared, but sales declined---not a good combo,
(4)
macroeconomic: the latest Fed Beige Book report was
modestly upbeat; the January trade deficit was larger than estimates; fourth
quarter productivity fell more than expected while unit labor costs were higher
than forecast.
The Market-Disciplined Investing
Technical
This week the
DJIA (14397) penetrated to the upside both the upper boundary of its short term
uptrend (13621-14292) and its former all time high (14190) and remained above
them for the duration of our time and distance discipline. That confirms the DJIA’s break, but not that
of the Market.
The S&P (1551)
didn’t even challenge the comparables of either of its short term uptrend (1484-1555)
or its all time high (1576). Until it
does, under our time and distance discipline, the Market’s breakout won’t be
confirmed.
That still leaves
open the question as to whether we are witnessing a topping process or a
consolidation in preparation for a launch higher. I have noted that (1) our internal indicator
suggests that latter but (2) if it happens, there is only about circa 10% to the upside left on the S&P before in
encounters the upper boundary of an eighty year uptrend.
Meanwhile, both of
the Averages are within their intermediate term uptrends (13453-18453, 1423-2017).
Volume was flat on
Friday; breadth improved with the flow of funds indicator continuing its sizz
to the upside. The VIX was off but remains
in both a short term and intermediate term downtrend---a positive for stocks.
GLD rose but
remained near the lower boundary of its short term downtrend
Bottom
line:
(1)
the S&P is trading within its short term uptrend [1484-1555]
while the Dow finished above the upper boundary of its short term uptrend
[13621-14292]. They both closed within
their intermediate term uptrends [13468-18468, 1427-2021].
(2) long term, the Averages are in a very long term [80 years] up trend
defined by the 4873-17500, 688-1750.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (14397)
finished this week about 26.8% above Fair Value (11350) while the S&P (1551)
closed 10.3% 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. The good
news is that it seems like progress is being made in dealing with our fiscal
issues. If our political class actually
does the right thing (lowers the debt to GDP
and deficit to spending ratios), that would improve not only our economic
outlook but would help multiples.
The bad news is
that the Fed seems hell bent on pushing money creation further into uncharted monetary waters. Nobody knows exactly how this situation will
resolve itself because we have never been in such an expansive period in
monetary policy before. We have, however,
been lived through periods of much too easy money; and we know that they didn’t
end all that well. I have some higher inflation built into our Valuation Model;
but I fear not enough. So I may have to
raise that assumption at some point with the result being a decline in P/E’s.
Finally, Europe
continues to deteriorate both economically and politically while the eurocrats
fiddle. Yet it is ‘muddling through’;
how I don’t know except to observe that easy money seems to be buying the
political class a pass. At some point, I
think that this will end badly but I have no clue as to when. Nevertheless, I believe that when it does (1)
the odds of averting a crisis will be lower than they were on the previous
occasion and (2) the tail risks [damage to US
corporate profitability as well as the global banking system] will have grown
in magnitude.
My investment conclusion: nothing has happened (data, the Fed, fiscal
policy) that would warrant a change in the assumptions in our Valuation
Model. Hence, stocks remain overvalued and
are getting more so each day.
However, the risks of a deeper European
recession/financial debt crisis are rising.
These could affect 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 except that they will have a negative impact.
Finally,
it is extraordinarily frustrating to be cautious on valuations in the midst of
a moon shot. However, fundamentally, no
matter how I massage the numbers, I can’t get Fair Value much higher than it is
presently. Despite a good week of data,
the growth just isn’t there. To be sure,
if the political class finally does the right thing and addresses our budget
problems in a meaningful way, the longer term outlook improves; but I can’t
bring myself to start discounting that after one White House dinner. On the other hand, Fed policy and the EU’s
debt problems are like grenades in our jockey shorts---it is tough being
optimistic about the future until they are properly dealt with.
But
let’s forget fundamentals for a moment.
While stocks are certainly smoking right now, the S&P is a mere
10-12% away from encountering the upper boundary of an 80 year uptrend---that
is the best I can come up with on the reward side of the equation. Clearly the argument can be made that stocks
can touch that high and hug for some time to come. But that assumes that (1) stocks only go up
and mean reversion is a antiquated concept and (2) I am smart enough to know
when the jig is up. I hate to disabuse
you of the latter notion, but I am not that smart. So the risk side of my equation is a minimum
of 9-10% down if stocks just return to Fair Value. God forbid that they fall to the lower
boundary that 80 year uptrend (688).
So
as wrong as I am at the moment for carrying a larger than normal cash position,
I still choose to rely on our disciplines.
This week, our Portfolios continued their program of lightening up
on those stocks that traded into their Sell
Half Range
12 chart battleground (medium):
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 14397 1551
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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