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 13685-14366
Intermediate Uptrend 13498-18498
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 1492-1567
Intermediate
Term Uptrend 1433-2027
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
an average week for economic data flow; all in all, I would judge it as mixed
with both really bright spots (February retail sales and February industrial
production) and some not so good news (March consumer sentiment): positives---weekly
retail sales, February retail sales, weekly jobless claims, small business
sentiment, February industrial production, the fourth quarter current account
deficit and the February budget deficit; negatives---weekly mortgage and
purchase applications, February PPI and CPI ,
March consumer sentiment and the NY Fed manufacturing index; neutral---February
core PPI and CPI .
As I have said before, mixed data is not
particularly concerning especially when the good news part includes better
retail sales and higher industrial production.
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 big four economic indicators (medium):
The
pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy. Lousy economic data continues to come
out of China . Another week of this and I will remove it
from the pluses.
This
just hit Friday afternoon (short):
However, here is some good
news (medium):
The
negatives:
(1)
a vulnerable global banking system. This week low light was the Senate Finance
Committee’s review of JP Morgan [our ‘fortress’ bank to quote a talking head]
in which this august institution was accused of lying, mismanagement and the
inappropriate assumption of risk [i.e. an uncontrolled and excessive exposure
to derivatives].
All
of these are must reads:
And:
And:
Joining in the fun, British regulators
estimated losses on UK bank balance sheets could reach $90 billion
(medium):
For
the hat trick, don’t forget the Kyle Bass piece on Japan ,
I linked to on Tuesday
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.
‘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’. Two positives to note:
[a] the
economic data flow continues relatively upbeat as the time period that captures
the impact of the January tax increase is being released---a sign of the
underlying strength in the economy. We
don’t know yet if the sequestration alone or in conjunction with the tax
increase will start to impede growth; but so far it hasn’t. And as you know, I don’t believe that it will
be.
[b] Obama
continues his charm offensive, telling republicans Thursday night that He
favored tax and entitlement reform.
While I am a cynic when it comes to Obama’s motivations, I can’t deny
that the above sounds very hopeful. But
we must await more information before assuming that this transformation in
attitude is real.
As I noted
last week, if Obama has truly changed character, if He is willing to negotiate
in good faith toward some sort of more fiscally sound budget outcome and if it
actually occurs, this would be a major positive. It would move fiscal policy from a negative
to a positive in our economic outlook. Of course, that is a lot of ‘ifs’; so
for the moment, government spending and taxes remain a negative.
A problem ...... 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 .....
(3)
rising inflation:
[a] the potential negative impact of central bank money printing. Easing continues at full throttle. This week the Chinese expanded their
criticism of too much money printing to the global central banks after banging
on the Japanese last week. As I noted,
if they get pissed and decide to take the Japanese or the Fed to task, they can
cause some heartburn. Nevertheless, the
banksters appear to be ignoring the warnings and continuing the race for the
title of ‘most bloated balance sheet in the universe’.
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. This week, economic conditions continued to
deteriorate with employment and industrial production weakening across the
continent, spiced up by a UK
report on a worsening in domestic bank balance sheets and heartburn in the
Italian and Spanish debt markets.
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.
Fiscal policy is now on hold; but there is some probability (however
small I think it may be) 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.
Meanwhile, the
rocket scientists over at the Fed are doing their damnest to insure that we
experience something worse that 2000 or 2007.
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. Meanwhile,
the EU economy is faltering which will likely only exacerbate the funding and
servicing of overly indebted countries and overly leveraged banks. That said, investors continue to give the
eurocrats a pass; so the current slow walk to disaster can go on 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 fell,
(2)
consumer: weekly retail sales improved again and
February retail sales soared; weekly jobless claims fell versus expectations of
an increase; March consumer sentiment plunged,
(3)
industry: February industrial production came in higher
than anticipated; January business inventories rose more than estimates though
sales couldn’t keep up; February small business sentiment improved; the March
NY Fed manufacturing index were shy of forecast,
(4)
macroeconomic: the February PPI and CPI
headline numbers came in a bit hotter than expected; however, ex food and
energy, they were in line; the fourth quarter current account deficit was below
anticipated; and the February budget deficit was slightly less than estimates.
The Market-Disciplined Investing
Technical
The DJIA (14514)
remains above its previous all time high (14190) and the upper boundary of its
short term uptrend (13685-14366). It
closed within its intermediate term uptrend (13498-18498) and its long term
uptrend (4783-17500).
However, the
S&P (1560) remains below its previous all time high (1576) and the upper
boundary of its short term uptrend (1492-1567).
So for one more day, the break out of the Dow is not confirmed. The S&P is within its intermediate term
uptrend (1433-2027) and its long term uptrend (688-1750).
For the second
week, we are left with 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 at least an S&P assault on 1576 will occur but (2) even if it is
successful, there is only about circa 10%
to the upside left before it encounters the upper boundary of an eighty
year uptrend---which I don’t believe it will surmount.
Volume was up
big; but that was due to quadruple witching.
Breadth deteriorated. The VIX was
unchanged and so it remains in both a short term and intermediate term
downtrend---a positive for stocks.
GLD rose but
remained in its short term downtrend. It
continues to hold above a developing support level.
Bottom
line:
(1)
the S&P is trading within its short term uptrend [1492-1567]
while the Dow finished above the upper boundary of its short term uptrend [13685-14366]. They both closed within their intermediate
term uptrends [13498-18498, 1433-2027].
(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 (14514)
finished this week about 27.8% above Fair Value (11350) while the S&P (1560)
closed 10.9% 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. However, we
at least have a chance that the political class will come up with a meaningful
compromise on setting the budget on a sustainable path. It is much too early to build such an
assumption into our Valuation Model; but were it to occur, it would certainly
have a positive impact on our long term corporate profit growth rate and on the
discount factor (P/E’s).
On the other
hand, every week that goes by adds another $20 billion to the Fed balance
sheet. While we don’t know where this
will end, we do know how two similar monetary expansions ended (2000, 2007);
and as you know, they weren’t pretty.
Regrettably this time around, Bernanke’s money printing puts those
previous examples to shame.
As you know, I
believe that the outcome this time around (i.e. inflation) will simply be a
worse version of the prior occasions. In
attempting to reflect its potential outcome in our Models, I have built a rising rate of inflation into our Economic
Model and adjusted the future discount factor in our Valuation Model. However, I feel reasonably sure that these
current assumptions inadequately deal with this situation because we have never
been in these uncharted waters of monetary expansion before. So my best shot in coping with this unknown has
been to push our Portfolios’ cash positions to an above average level in
compensation for my inability to quantify the risk.
That goes double
for Europe .
Economic, social and political conditions continue to degenerate while
sovereign debt ratios rise and banks become even more leveraged. The amazing thing is that investors have
provided a window of opportunity to the eurocrats to fashion measures to deal
with this problem; and those eurocrats have elected to do nothing---except
smoke cigars, drink whiskey, chase skirts and slap each other on the back
praising their collective wisdom. This
too I fear is going to end badly.
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.
Further, the risks of a European
recession/financial debt crisis are rising.
These could affect our profit assumptions in both Models and our P/E
assumption 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.
Our Portfolios’ extraordinarily high cash
is compensation for not being able to adequately model the risks of a
promiscuous Fed and a continent led by a bunch of unrealistic, self serving
nogoodniks.
This week, the High Yield Portfolio sold its position in TC Pipeline
(TCP ) after the company failed to pass its most
recent financial quality check up.
Message to myself: don’t chase (short):
The
latest from Howard Marks (medium and a must read):
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 14514 1560
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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