The Closing Bell
Note: I have the good fortune of marking one off my bucket list next
weekend. I am going to the Masters. We leave Thursday morning; so Wednesday will
be the last communications until the following Monday.
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 13924-14622
Intermediate Uptrend 13655-18655
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 1524-1598
Intermediate
Term Uptrend 1447-2041
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. The
economic data was weighted to the negative this week: positives---weekly
purchase applications, weekly retail sales, February factory orders and the
February trade balance; negatives---weekly mortgage applications, weekly
jobless claims, the ADP private payroll
report, March nonfarm payrolls, both the ISM manufacturing and nonmanufacturing
indices and February construction spending; neutral---March vehicle sales.
The standout numbers were the employment stats
which were clearly disappointing. I have
said many times that one week’s data by itself is not meaningful in the grand
scheme of things. What is important is
the trend; and the trend at the moment is towards an improving economy, this
week’s lousy numbers notwithstanding. On
the other hand, we can’t just ignore the consistency of the poor employment
figures. I look at this as a potential warning signal (potential being the
operative word) with time and more data confirming or denying any change of
trend.
Hence, our
outlook remains unchanged:
‘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 economics indicators (medium):
The
pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy.
The
negatives:
(1)
a vulnerable global banking system. This week’s episode is the report from the MF
Global trustee, telling us what we already knew: the company took too many risks and had
inadequate management controls.
‘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)
fiscal policy. This
factor has become somewhat less of a negative of late as [a] the fiscal cliff
was resolved, [b] the sequester was implemented, [c] the continuing resolution
was passed and [d] the rhetoric over the debt ceiling has subsided. The results of these actions were not optimal
but they at least partially addressed the deficit and/or took the risk of a
government shutdown off the table.
The budget
process will begin in earnest [is that an oxymoron?] next week as Obama will
present His budget. Rumors are that it includes
both entitlement reform and tax increases which would offer an opening bid on
the two things we need for a ‘grand bargain’.
I consider that a good start. If
our ruling class can implement meaningful tax reform and reduce government
spending and the deficit, that could help get our economy moving back toward
its long term secular growth rate. If
that happens, fiscal policy would become a positive.
Nevertheless, I
remain concerned about...... 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, the Bank of Japan one-upped itself on monetary ease, vowing to double the
monetary base in the next 24 months. It
would seem that the Japanese are doubling down on our own Fed policy,
presumably assuming that all that money pumped into the US
financial system has at least generated sub par growth. What I fear that they are missing is that {i}
our banks have used most of the free money for speculative purposes, increasing
trading activities and funding the growth of auto and student loan bubbles {ii}
and as a result, this new infusion of global liquidity will only exacerbate
this problem.
As you know, I
don’t believe that the current massive injection of liquidity is not 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 South Korean reaction to the Japanese triple all in policy statement}. ‘ 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. Over the last two weeks, the focus has been
on Cyprus , the
handling of which by the eurocrats is a perfect illustration of why the EU
sovereign/bank insolvencies have me so concerned.
The final solution
[after three failed attempts] included a plan to [a] restructure the banks, [b]
penalize the risk takers {shareholders, junior and senior creditors and
uninsured depositors} and [c] institute capital controls. As you know, I liked at
least a part of that solution because it generally followed bankruptcy law---something
that hadn’t happened in prior EU bailouts.
In addition, it had the benefit of being hailed as the ‘template’ for
future bailouts. In other words, the
rules of the game were finally set, they generally followed the rule of law and
everyone would now know them.
Well, that
lasted only a couple of days. Thursday,
Draghi announced that Cyprus
was not a template, putting the bail out process back at square one, i.e. the
rule of law is a nonfactor and there is no template. That means that God only knows what the
solution to the next crisis will look like; and it leaves open the possibility
that [a] the eurocrats will make another arrogant mistake like the ‘taxing’ of
Cypriot insured deposits but [b] with the accompanying risk that it can’t be
walked back as it was in Cyprus.
In addition,
there is growing evidence that the capital controls provision ended up only
applying to the little guy. Apparently,
the Russian oligarchs and many of the Cypriot wealthy got their money out
before either were dinged with the tax on uninsured deposits or being subject
to the capital controls.
So now we have
a situation with [a] the European economy continuing to deteriorate, making it
seemingly only a matter of time before another crisis arises but [b] no rules
to define its resolution save the whims of the eurocrats which time and again
have been proven to include saving the rich and powerful---not a formula that
instills confidence.
Bottom line: the US
economy remains a positive for Your Money, though this week’s employment data
raises a warning flag. We will know more
about fiscal policy shortly as the ruling class gets back to work on a
budget. However, so far, Obama is
sticking with His charm offensive; so there remains 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---though at the moment, this is
nothing more than a wet dream.
Meanwhile, the
Fed policy continues to streak into uncharted waters. The Bank of Japan actually upped the ante
this week. Regrettably, I am not smart enough to know when Markets
will cease to tolerate this irresponsible behavior by the central banks or what
the magnitude of the fall out will be when they do. My guess is that it won’t be pretty and 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. Indeed,
with the Cyprus
‘solution’, they are probably further away---no one knows what the rules are
except that the rich and powerful will be protected.
Unfortunately,
an EU wide loss of investor/voter confidence stemming from this could exacerbate
the risks of (1) a deeper recession in the EU with spill over effects in our
own economy and (2) a bankruptcy in the financial system that would result in a
Lehman Bros/AIG -like explosion of derivative
counterparty failures. As I have noted
in the past, I have no idea how to model such an occurrence.
The role of
trust in macro economics (medium):
This week’s
data:
(1)
housing: weekly mortgage applications fell while
purchase application were up,
(2)
consumer: weekly retail sales were strong; March
vehicle sales were flat; weekly jobless claims, the March ADP
private payroll report and March nonfarm payrolls were below forecasts though
there were some adverse seasonal factors affecting the jobless claims stats,
(3)
industry: both of the March ISM reports were
disappointing; February construction spending was slightly below expectations;
while February factory orders were a bit ahead of estimates,
(4)
macroeconomic: the February trade balance narrowed.
The Market-Disciplined Investing
Technical
The indices (DJIA-14565,
S&P 1553) continue to trade within all major uptrends: short term (13924-14622,
1524-1598), intermediate term (13655-18655, 1447-2041) and long term (4783-17500, 688-1750). However, they remain
out of sync on surmounting their all time highs---the Dow having done so (14190),
the S&P not (1576).
Clearly, with
all those uptrends in tact, it is near impossible to suggest that the Market
has rolled over. Indeed, Friday’s
intraday comeback after an early and rough nonfarm payrolls number indicates
that the bulls are still in there bidding.
On the other hand, the lack of confirmation of the DJIA’s new high plus
the noticeable weakening in the Market internals makes assuming that stocks are
going higher problematical.
I think that the
best strategy at present is step back and let the bulls and bears duke it out
for control of direction---though if one of our stocks hits its Sell Half
Range, I will likely act.
Volume on Friday
rose; breadth declined. The VIX was up
fractionally, finishing within its short and intermediate term downtrends---a
positive for stocks.
GLD snapped back
smartly, closing back above that developing support level the day after
negating it. At this point, the pin
action over the next couple of days will
tell us whether there is any strength in this support level.
Bottom
line:
(1)
the indices are trading within their short term uptrends
[13924-14622, 1524-1598]and intermediate term uptrends [13655-18655,
1447-2041]. However, the S&P is not confirming the DJIA’s breakout above
its all time high.
(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 (14565)
finished this week about 27.7% above Fair Value (11400) while the S&P (1553)
closed 9.9% overvalued (1412). 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; though as I noted above, we did get a warning
signal this week.
No news on
fiscal policy. But I remain open to the
notion that some sort of fiscally responsible budget compromise could be
reached that would in turn change this from a negative to a positive in both
our Economic and Valuation Model. That
said, the proof of the pudding is in the eating; and we are not there yet. So hope is the operative word.
On the other
hand, global monetary policy gets scarier by the day. We are in the midst of a grand, though I fear
very dangerous, experiment. It is very
difficult to make assumptions in our Models when we are going where we have
never gone before. Hence, I am losing confidence
in the output of both our Economic and Valuation Models.
Moving on to Europe ,
its economy is worsening and the eurocrats continue to undermine
investor/electorate confidence. I don’t
know how a ‘muddle through’ strategy holds up in that environment. That said, I remain perplexed that no matter
how dire the circumstances and no matter how unsavory the eurocrats’ temporary
fixes, the electorates and investors continue to take it all in stride.
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 remain
passive despite inequities imposed by the eurocrats, then ‘muddle through’ will
remain the default scenario.
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, that is a function of not knowing
how to model the current, unprecedented explosive growth in global money supply
and not because I have confidence in my assumptions.
The EU recession/financial debt problems
keep getting worse; but 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 of their misguided leaders’ actions. This situation remains an enigma to me.
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 4/30/13 11400 1412
Close this week 14565 1553
Over Valuation vs. 4/30 Close
5% overvalued 11970 1482
10%
overvalued 12540 1553
15%
overvalued 13110 1623
20%
overvalued 13680 1694
25%
overvalued 14250 1765
30%
overvalued 14820 1835
Under Valuation vs.4/30 Close
5%
undervalued 10830 1341
10%undervalued 10260 1271
15%undervalued 9690 1200
* 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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