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 13545-14200
Intermediate Uptrend 13453-18453
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1476-1545
Intermediate
Term Uptrend 1423-2017
Long
Term Trading Range
766-1575
Very
LT Up Trend 651-2007
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 39%
High
Yield Portfolio 40%
Aggressive
Growth Portfolio 40%
Economics/Politics
The
economy is a modest positive for Your Money. We got
a lot of data this week and it shifted last week’s negative tilt back to a more
neutral (mixed) picture: positives---new home sales, the Case Shiller home
price index, weekly retail sales, weekly jobless claims, both consumer
confidence indices, January durable goods ex transportation, the February Chicago
PMI , the February ISM manufacturing index and
the Richmond Fed manufacturing index; negatives---weekly mortgage and purchase
applications, the Dallas and Kansas City Fed manufacturing indices, the Chicago
Fed national activity index, January personal income, January construction
spending, durable goods orders and the fourth quarter GDP
deflator; neutral---fourth quarter revised GDP
and January personal spending.
The continuing erratic flow of economic data
has been an enduring feature of the economy’s recovery over the last three
years. As long as this pattern remains
the same and so will our forecast:
‘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
We
received a surprising bonus yesterday when the state department ruled that
there were no environmental issues with the revised route for the Keystone
pipeline. That doesn’t mean construction
starts tomorrow, but it is a positive.
(2) an improving Chinese economy. This week, we got another disappointing
number---this time PMI . Much more of this and I will have to drop
this factor as a positive.
The
negatives:
(1)
a vulnerable global banking system. This week’s noteworthy item perfectly illustrates the accounting
chicanery that occurs on the large bank trading desks. It was a regulatory investigation into Credit
Suisse self dealing. The below link
explains much better than I could:
Again this
illuminates [a] the potential risk that exists on any one bank’s balance sheet
and [b] because of the counterparty risk via derivatives, becomes a potential
risk on all banks’ balance sheets.
‘My concern here is that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and well
managed as we have been led to believe and, hence, are highly vulnerable to
future shocks, particularly a collapse of the EU financial system.’
(2)
the ‘debt ceiling/sequestration/continuing resolution
cliff’. March 1 has come and gone. While I have been a skeptic, the GOP didn’t
fold---and that is a positive. That
doesn’t mean that we are headed for Nirvana; but it is a first step however
small. The good news is that the heat
will stay the republicans to follow through with more fiscally responsible action
because continuing resolution deadline also falls in March. Having been wrong on the sequester call, I am
going to stay neutral for the moment on republican resolve. But we will clearly have a better picture by
March 31 of how much real progress that we can expect reversing the
current budget profligacy. Should the GOP hold firm, this would be a
major plus for our long term outlook.
Short term,
the issue is how much will sequestration and any subsequent spending reductions
impact our economic growth. As you know,
I believe that the more money that gets left in Americans’ pockets versus
inefficiently spent by the government is a positive. Most of the MSM
and the pundits they interview disagree with that notion. They almost universally categorize the
sequestration cuts as ranging from unpleasant to catastrophic. I think the only way that happens is if the
cuts are applied to highly visible functions that many Americans use [e.g.
airport security].
The reason is
simple. I know that over the last four
years in my own personal finances as well as those of companies that I advise,
spending cuts have been made by both eliminating waste and figuring out to do
the same function for less. And we are
all better off for having been through it.
I see no difference with the government.
I suggest to you that if the cabinet secretaries can’t find five percent
waste in their departments and/or find ways to accomplish their functions for
less money, they shouldn’t be cabinet secretaries.
Sure some
government functionary isn’t going to get paid; but either [a] some business
gets to keep that money {versus being taxed} and spend it on far more
productive purposes or [b] an investor buys a corporate bond versus a
government bond and again the money is put to a more productive use. And let’s
not forget that the total sequestration is $85 billion PER
YEAR; in the meantime, the Fed is pumping $85 billion A MONTH into the economy.
Bottom line: I am sticking with my opinion that any cuts in government spending
will be 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. Bernanke testified before congress for two
days this week. If anything came out of
that process, it was that {i} the Fed is easy and will remain easy for as far
as the eye can see and {ii} the FOMC minutes from the prior week should in no
way be interpreted as a prelude to tightening.
While investors
got jiggy with it, I believe that Fed policy will in the end prove disastrous
for the economy; and the longer it goes on, the more disastrous the end
game. That judgment is based on history,
to wit, the Fed has never, ever, ever, ever {you get the picture} managed a
successful transition from easy to tight money without causing either a
recession or high inflation.
As you know, my
bet is that tightening won’t happen soon enough; so we get what is behind door
number two: inflation [a] Bernanke has already said {too
many times to count} that when it comes
to balancing the twin mandates of inflation versus employment, he would err on
the side of unemployment {that is, he won’t stop pumping until he is sure
unemployment is headed down}. That can
only mean that the fires of inflation will already be well stoked before the
Fed starts tightening and [b] history clearly shows that the Fed has proven
inept at slowing money growth to dampen inflationary impulses---on every
occasion that it tried.
Bernanke’s inflation record
is a joke (medium):
George Will on the Fed
(medium):
A corollary concern is that all
this money printing increases the potential for a currency war. ‘ an
overly easy monetary policy generally results in the depreciation of the
currency of that bank’s country which in turn improves that country’s trade
balance and strengthens its economy.
That is great unless its trading partners get pissed and commence their
own ‘easy money/currency depreciation’ effort. At that point, you got yourself a currency
war; and that seems to be the direction that the major economic powers are
headed in.’
Of course, there is a
downside to debasing your currency. For Japan ,
the chickens are coming home to roost.
Which apparently won’t stop
further easing (medium):
[b] a blow up in the Middle East . Syria
continues to be the hottest spot in this almost universally troubled
region. This week, Putin turned up the
heat there, making it clear beyond any doubt that the Assad regime is now a
Russian client and he would do whatever necessary to insure its survival.
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, the major development was the
victory of two anti austerity parties in the Italian elections and, hence, the
uncertainty that casts [a] on that country’s fiscal policy and [b] the support
that country will continue to receive from the ECB. At the moment, this train wreck is proceeding
in slow motion which seems to be having the effect of allowing the eurocrats to
continue to rationalize that it really isn’t a train wreck at all---something
at which they have demonstrated remarkable skill over the last several
years.
As usual, investors
refuse to hold the eurocrats to account for their inaction in dealing with the
current sovereign/bank insolvency problems.
As a result, when coupled with a the worsening economic climate, the
risks grow that a sick EU will at the very least negatively impact global economic
activity and at the worse precipitate another state or financial institution
bankruptcy that potentially exposes the world banking community to another
round of counterparty defaults.
Bottom line: the US
economy continues to grow at a historically below average secular pace; and I
see little domestically that would alter that scenario. Sequestration will almost certainly not be
the disaster that Obama and His sycophantic whiny butt supporters make it out
to be. In fact, as I have said
frequently, I consider it a positive.
Bernanke assured
all this week that Fed policy is unlikely to change its easy money policy in
our life time. That just digs the hole
deeper from which the Fed will ultimately have to extract itself, leaving us
facing a worse recession or higher inflation than would otherwise occur. I have said that I expect the bad medicine to
come in the form of inflation. At least
some of that is already in our Economic Model---although at some point, I may
have to revise upward our inflation expectations.
The biggest risk
to our Models remains multiple European sovereign/bank insolvencies. The likelihood of those happening has
probably increased as the EU economy slips further into recession and the
eurocrats slip further into inaction.
That said, ‘muddle through’ is the operative scenario until either one
or more electorates or the Markets hold the ruling class to account.
The latest from
Charles Biderman (6 minute video):
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
down; January new home sales were very strong; the December Case Shiller home
price index was up slightly more than anticipated,
(2)
consumer: weekly retail sales improved again; weekly
jobless claims declined more than expected; January personal income was
disappointing while spending was on target; both the Conference Board’s index
of consumer confidence and the final University of Michigan’s index of consumer
sentiment improved,
(3)
industry: January durable goods decreased although ex
transportation they rose more than forecast; the February ISM manufacturing
index was stronger than expected while construction spending was worse; the Dallas
Fed February manufacturing index dropped in half; and the Kansas City Fed index
also was disappointing; however, the Richmond Fed’s index was better than
estimates; the January Chicago Fed national activity index was horrendous but
the February Chicago PMI was ahead of
forecasts,
(4)
macroeconomic: fourth quarter GDP
was revised up [+0.1% versus -0.1%] though not as much as expected while the
deflator came in hotter than anticipated.
The Market-Disciplined Investing
Technical
The indices
(DJIA 14089, S&P 1518) finished within both their short term uptrends (13545-14200,
1476-1545) and intermediate term uptrends (13453-18453, 1423-2017). As you know, the Market has been struggling of
late in one of its periodic schizophrenic churns. I don’t know if this is part of a topping
process or stocks are simply preparing for a run at the Market highs. At this point, all we can do is watch and have
a strategy set for either alternative---which we do: sell into additional strength
and hold off buying on weakness until stocks return to Fair Value at a minimum.
Volume on Friday
declined; breadth was mixed. The VIX was
off fractionally but remains in both a short term and intermediate term
downtrend---a positive for stocks.
GLD fell and
closed right on the lower boundary of its short term downtrend. While it remains above the lower boundary of
its intermediate term trading range, it still acts like a sick puppy. So we are staying away for the time being.
Bottom
line:
(1)
the Averages are trading within their short term
uptrends [13545-14200, 1476-1545] as well as their intermediate term uptrends
[13453-18453, 1423-2017].
(2) long term, the Averages are in a very long term [78 years] up trend
defined by the 4546-15148, 651-2007 and a shorter but still long term [13
years] trading range defined by 7148-14198, 766-1575.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (14089)
finished this week about 24.1% above Fair Value (11350) while the S&P (1518)
closed 7.9% 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. I have
opined that the sequestration will have little impact on the economy; although
it was, in truth, not a half assed compromise.
Nonetheless, we are still faced with the continuing resolution debate in
March and the debt ceiling negotiations later in which we can get a less than
optimal solution. Further, the Fed
strategy of ‘print to infinity’ is alive and well. Since burdensome government spending and
excessive money printing are in our Economic Model, nothing has changed
domestically to alter the assumptions in our Valuation Model---at least in this
week.
Looking into
March, if the GOP has the cojones to stick with its new found religion of fiscal
responsibility, then there is reason for optimism. We will know much more about any change of
heart by the end of the month since Washington
is faced with the aforementioned negotiation in that period. For the moment, we all need to say our
prayers.
Further,
somewhere out there near infinity, the Fed is going to have to reverse
course. I am not cure what the catalyst
will be and I am not sure when in happens.
Clearly, as long as investors drink the Kool Aid that Bernanke is
selling, it can be postponed. But there
will be a day of reckoning; and when that happens, changes in both our Economic
and Valuation Models may be necessary.
Finally, Europe
continues to deteriorate both economically and politically; and the eurocrats are
resolutely doing nothing to attack the underlying causes of sovereign/bank
insolvencies. Indeed, the entire
continent seems to be sleep walking through this deteriorating
environment.
That said, our
forecast is for Europe to ‘muddle through’’ and so far,
that is exactly what it has done; and to be fair, to date it has skirted
disaster even as conditions have gotten worse.
When will it end? Like I said
above regarding Fed policy, this can go on until somebody cries ‘uncle’. When that happens, I suggest that (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,
sequestration) that would warrant a change in the assumptions in our Valuation
Model. Hence, stocks remain
overvalued.
However, the risks of a deeper European
recession/financial debt crisis are rising.
These could effect our profit assumptions in both Models and our P/E
assumptions in our Valuation Model. The
problem is that I still can’t quantify those dangers associated with a severely
wounded financial system except that they will have a negative impact.
This week, our Portfolios did nothing.
The latest from Stanley Druckenmiller (medium/long):
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 14089 1518
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
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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