The Closing Bell
Note: I am going to take a couple of extra days for the Memorial Day
holiday. So no Morning Calls next
Thursday and Friday and no 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 14467-15176
Intermediate Uptrend 13944-18944
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 1586-1663
Intermediate
Term Uptrend 1479-2067
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 41%
High
Yield Portfolio 42%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s economic data was basically mixed: positives---April building permits, April retail sales, March business sales,
April PPI and CPI , the April NFIB Business
Optimism Index, May consumer sentiment and April leading economic indicators;
negatives---mortgage and purchase applications, April housing starts, weekly
jobless claims, April industrial production and capacity utilization and the
May NY and Philly Fed manufacturing indices; neutral---weekly retail sales. After a positive though admittedly sparse
week for data flow last week, the above pattern returns the overall trend in
the numbers to mixed. That is not
atypical for this recovery. So, nothing
here to warrant a change in our Economic Model.
Overseas, Europe
followed the same pattern; that is, after a brief respite of upbeat economic
news, the stats this week took a turn back toward the negative side. The standout datapoint was a decline in first
quarter EU GDP . While this clearly wasn’t encouraging, our Model
does assume a weak (plus or minus one percent real growth), though not
dramatically recessionary, European economy.
So while the
amber light on recession is flashing, 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 big four economic indicators (medium):
And
(short):
The
pluses:
(1) our improving energy picture.
The US
The
negatives:
(1) a vulnerable global banking system.
Surprise, surprise. We actually
made it week without any reports of bad boy behavior from the banksters.
Never fear,
there is always plenty of other problems, like nonperforming loans in the
European financial system (medium):
‘My
concern here.....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. Benghazi
was replaced by the IRS and AP scandals this
week; meaning that congress continued to focus on something other than the
budget. Short term, that is not
necessarily a bad thing in that [a] the sequester and the tax hikes are doing
the job of reducing the budget deficit and [b] it takes the ruling class’
attention off of screwing you and me---again.
On the other
hand, it may relieve the pressure of having to do any real work--- like
entitlement and tax reform. And absent
those reforms, the US
economy will likely remain stuck on its current sub par growth path as it
struggles to overcome the massive federal debt as well as 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 .....
I remain open
to the possibility that congress will address the twin long term budget
problems of entitlement spending and tax reform; however, with Obama dodging
bullets from all directions, I am less hopeful than I was a month ago.
(3)
rising inflation:
[a] the
potential negative impact of central bank money printing. As I am fond of repeating, past bouts of
irresponsible monetary easing have ended in either recession or inflation as
central banks have shown themselves incapable of managing the transition from
easy to tight money; and I see no reason why it would be any different this
time.
Indeed, if
anything, it could be worse in that we have never witnessed a ramp up of money
printing on the current scale.
On the other
hand, the simultaneous weakening in the US ,
EU and Chinese economic data could portend recession and that would likely postpone
the transition period from easy to tight money---at least for the short term. The downside is that this would probably
prompt the central banks to pour even more money into the global financial
system, ultimately making this problem even worse than it already is.
Whatever
happens, the fact remains that sooner or later, those bank reserves have to be
withdrawn. It may be in a day, a month,
a year, two years or five years; but when it does occur, the Fed along with other
central banks will have the same problem that they have had every time they
transitioned from easy to tight money.
Other problems,
aside from the fact that this massive injection of liquidity has not
accomplished the central bankers’ goal, are that:
{i} our banks
have used this largess for speculative purposes, increasing trading activities
and funding the growth of auto and student loan bubbles---and now perhaps a new
mortgage bubble. The popping of any/all
of these bubbles would likely drive the US
economy back into recession,
A different
take on student loans (medium):
{ii} any new infusion of global liquidity will likely only
exacerbate this problem.
In addition,
one of the corollaries of too much money printing is the rise in 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.’
So you can see
how what might start out as a run of the mill economic slowdown could be made
worse by the popping of various asset bubbles and/or an intensifying race of
competitive devaluations.
One final note,
the Japanese bond market has been taking it in the snoot for the last two weeks. Lest we forget, total Japanese government
debt is over 200% of GDP; so if interest rates keep rising, the cost to service
that debt keeps rising which has to be paid for with taxes or more bond
issuance---neither of which will be particularly welcomed. [must read]:
And that says
nothing about what happens to rates on the rest of the world’s debt. I will repeat that I don’t know how this
story ends; but the odds of it ending badly are high enough to warrant caution.
[b] a blow up
in the Middle East .
Both the US
and Russia are
sending naval vessels into the vicinity [US to Israel ,
Russia to Cyprus ]. My worry is that if violence erupts, it may
in turn lead to a disruption in either the production or transportation of Middle
East oil, pushing energy prices higher.
More insight
into the conflict in Syria
(long but a must read):
And:
(4)
finally, the sovereign and bank debt crisis in Europe
remains a major risk to our forecast. This week, the data flow out of the EU turned
more negative. The bad news is that
given the level of sovereign indebtedness, the overleveraged European bank balance
sheets and the [low] quality of the assets on those balance sheets [see ‘a
vulnerable global banking system’ above], the EU economy is much more susceptible
to minor changes in growth than in the US.
The good news
is that [a] our forecast accounts for weak economic activity in the EU and [b] the
recent move by the ECB to ease monetary policy coupled with the call by the
eurocrats to back off austerity could help mitigate any recessionary pressures
short term.
Bottom line: the US
economy remains a positive for Your Money.
The budget deficit is shrinking faster than I thought but (1) it is
partly a function of income being moved from 2013 back to 2012 because of the
1/1/13 tax increase, (2) there is still much to be done on entitlement and tax
reform and downsizing an inefficient bureaucracy, (3) just when we thought that
the acrimony in Washington couldn’t get any worse, along comes Benghazi, IRS -gate
and AP-gate; that’s probably not conducive to productive negotiations on
structural change.
Fed monetary
policy along with that of the rest of the world has been jammed into overdrive.
‘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.’
This week’s
data:
(1)
housing: weekly mortgage and purchase applications declined
markedly; April housing starts were well below estimates though building
permits were quite strong,
(2)
consumer: weekly retail sales were mixed while April sales
were better than forecast; weekly jobless claims rose more than expected, the
initial May University of Michigan consumer sentiment survey came in at 83.7
versus estimates of 78.0,
(3)
industry: April industrial production and capacity
utilization were disappointing; March business inventories flat, though sales rose;
the April NFIB Business Optimism Index was better than anticipated; the May New
York and Philadelphia Fed manufacturing indices were weaker than forecast,
(4)
macroeconomic: both the April PPI and CPI
were softer than expected; April leading economic indicators were +0.6% versus
estimates of +0.3%..
The Market-Disciplined Investing
Technical
The indices (DJIA
15354, S&P 1667) ended the week on a very strong note, closing within all major uptrends: short term (14467-15176,
1585-1663 [both were above their upper boundary]), intermediate term (13944-18944,
1479-2067) and long term (4783-17500,
688-1750).
Volume was up
big time---contrary to its recent pattern of advancing on weak volume; breadth
was up. The VIX fell, finishing within
its short and intermediate term downtrends.
But it made no attempt to challenge the lower boundary of its long term
trading range.
This Market
reminds me of 2000; and I was just as early to Sell then as I am this
time. As nerve racking as this is, I
retain confidence in our Valuation Model.
So I am not capitulating and will continue to use upward momentum to my
advantage---taking profits when stocks trade into their Sell
Half Ranges
GLD was down big
and is now challenging its April low and the lower boundary of its long term
uptrend. As you know, I am watching that
closely.
Bottom
line:
(1)
the indices are trading within their short term uptrends
[14467-15176, 1585-1663] and intermediate term uptrends [13944-18944, 1479-2067].
(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 (15354)
finished this week about 34.3% above Fair Value (11425) while the S&P (1667)
closed 17.7% overvalued (1416). 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 assumptions
in our Model related to US economic growth and fiscal policy remain unchanged. To be sure, fiscal policy has become less of a
negative in the short term due to the budget deficit narrowing more rapidly
than I expected. However, as I noted
above, most of the reasons for this pleasant surprise are one off. Plus the truly debilitating aspects of fiscal
policy (entitlement spending and tax reform) remain unresolved. I have noted that a ‘grand bargain’ would
lead to me to raise my long term growth assumption which would in turn lift
Fair Value. But that seems a long way
away in now scandal ridden Washington .
The monetary
policy assumptions have to change. I am
just not smart enough to figure out ‘to what’.
The entire global central banking system is now printing money as fast
as it can. In the past easy money has
ultimately led to either recession or inflation; and presumably that will
happen this go round. Further, given the
unprecedented scale of the current liquidity infusion, one might conclude that
the scale of the subsequent recession or inflation would reflect that. But in the end, I just don’t know.
That said, with
a number of the larger economies threatening to slide back into recession, the
drop dead date for a move from ease to tightening could be postponed. And that may lead to money printing at an
even more furious pace.
The point on
monetary policy long term is that if history repeats itself, (1) with monetary
easing now in uncharted waters, the transition from easy to tight [normal]
monetary policy will be a bigger negative for our Models than is currently
reflected; I just don’t know by how much, (2) given the potential for the US
and the EU to slide back into recession, the timing of the transition is even
more uncertain and (3) as a result, this risk is not properly reflected in our
Models.
My investment conclusion: most of the assumptions in our Models are
unchanged; though that of monetary policy almost assuredly will and to the
negative.
Certainly
nothing has occurred that improves equity valuations or persuades me to buy
stocks are current price levels. If
anything, the ever expanding race in global monetary easing has raised my
anxiety level to new heights.
This week, our Portfolios did nothing.
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 important.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 5/31/13 11425 1416
Close this week 15354 1667
Over Valuation vs. 5/31 Close
5% overvalued 11996 1486
10%
overvalued 12567 1557
15%
overvalued 13138 1628
20%
overvalued 13710 1699
25%
overvalued 14281 1770
30%
overvalued 14852 1840
35%
overvalued 15423 1918
Under Valuation vs.5/31 Close
5%
undervalued 10853 1345
10%undervalued 10282 1274
15%undervalued 9711 1203
* 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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