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 14245-14962
Intermediate Uptrend 13858-18858
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 1565-1642
Intermediate
Term Uptrend 1469-2058
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. The
economic data was mixed this week but once again tilted toward the negative:
positives---weekly mortgage applications, the Case Shiller home price
index, March personal spending, weekly jobless claims, April nonfarm payrolls, consumer
confidence and the March trade balance; negatives---weekly mortgage
applications, April vehicle sales, the ADP
private payroll report, the April ISM manufacturing and nonmanufacturing indices,
the Chicago PMI , the Dallas April
manufacturing index, April construction spending, March factory orders, first
quarter productivity and unit labor costs; neutral---weekly retail sales.
The US
economic numbers continue to slowly deteriorate, though investors have chosen
to focus on the employment data to the exclusion of other stats. At the moment, that is okay because, in
total, the numbers still have not reached the point to warrant a change in our
forecast. Nevertheless the risk that the
economy could slip into recession remains.
Exacerbating
this concern are lousy reports out of both Europe and China ,
though admittedly, there were a few upbeat datapoints out of the EU this week. In addition, Japan
seems to have gotten a lift recently from the Bank of Japan’s new triple down,
all in, balls to wall monetary policy.
The latter
notwithstanding, the amber light on recession is flashing; and as I noted in
Thursday’s Morning Call if the economic weakness in Europe
and China
continue to complement our own, the transition from sluggish to no growth could
happen much quicker than would otherwise have been the case.
For the moment,
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 economic indicators:
The
pluses:
(1) our improving energy picture.
The US
(2) an improving Chinese economy. The data out of China
continues to disappoint. One more week
of this and I will remove this as a positive factor.
The
negatives:
(1)
a vulnerable global banking system. We almost managed a week without hearing about more inexcusable behavior from the
banksters. Then, wouldn’t you know,
Friday morning we learn that JP Morgan [our fortress bank] has perpetrated yet
another scam---this time to defraud the state of California :
Why banks are
still ‘too big to fail’ (medium) new
‘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. With congress
on break, we didn’t get a lot of movement this week on the budget. However, the central issue is unchanged: can
our elected representatives reach some sort of ‘grand bargain’ that addresses
exploding entitlements and rationalizes the tax code in a way that stimulates
confidence and growth?
My bottom line is,
if they can, that could help our economy move back toward its long term secular
growth rate---in which case, fiscal policy would become a positive. However,
the Administration’s latest move to sacrifice the economy [its attempt to furlough
air traffic controllers] to forward its political agenda [more spending and
more taxes] may have lowered the odds of achieving meaningful fiscal reform.
I am also
worried 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. Under
our current forecast, the risk of a major mistake {i.e. inflation} in the
transition from easy to tight monetary policy grows daily as the Fed
relentlessly prints money and adds bank reserves. However as I noted above, if the recent simultaneous
weakening in the US ,
EU and Chinese economic data portends recession, that would likely render this
point moot---at least for the short term.
That is, it would almost certainly reduce demand on labor, production
and resources. Hence, any risk of
inflation would drop short term.
On the other
hand, the central banks would almost surely pour even more money into the
global financial system ultimately increasing the difficulty of absorbing all
those bank reserves without risking either a third recession or much higher
inflation.
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. Whenever that
happens, the Fed will have the same problem that it has had every time it has
transitioned from easy to tight money; only if a recession were to postpone it,
the magnitude of the transition will be exponentially larger than at any time
in the past.
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. And what better way to
pop a bubble than to slide into recession which would in turn make the
recession that much worse,
{b} any new infusion of global liquidity (Japan
and the EU) 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.
[b] a blow up
in the Middle East .
Syria continued
as the main regional flashpoint this week. 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.
(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
actually turned mixed. I don’t know if
this means conditions are improving or it is simply a brief respite before
further declines. Nevertheless, the ECB
joining the easy money crowd this week will undoubtedly provide sustenance to
notion that the EU will be improving economically.
However, we
need more information before declaring Europe on the
road to health. After all, as positively
as we might want to view the above, much of the southern European sovereigns
still have a long way to go on fiscal reform, the banks remain overleveraged,
the EU bureaucrats are as unpredictable as ever and if the ECB gets aggressive
in the money printing department, it will only add to the problems associated
with financial system deleveraging.
http://www.zerohedge.com/news/2013-05-03/global-slowdown-70-chinas-export-partners-saw-orders-plunge
On the other
hand, if the EU is healing, then our ‘muddle through’ scenario will have been
the correct call at least in the short term.
Deutsche bank raises capital (medium)
Bottom line: the US
economy remains a positive for Your Money, though it appears to be entering a
slower growth environment---hopefully only temporarily. While this could be the precursor to a
recession, it is far too early to tell.
Fiscal policy remains
uncertain as Obama appears to have not given up on an ideologically driven
political agenda in which He seems prepared to forgo economic growth to achieve
it. On the other hand, if the employment
data continues to improve and the Market stays in overdrive, He is going to
have a tough time selling the notion that cuts in government spending are a
negative for the economy.
The Fed went a
bit further out on the limb this week declaring in its latest FOMC statement
that it is prepared to increase monetary easing. Further, the ECB seems to be joining the
party. 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 applications rose but purchase
applications fell; the February Case Shiller home price index was very strong,
(2)
consumer: weekly retail sales were mixed; March
personal income was below expectations while personal spending was slightly
ahead; April vehicle sales were below estimates; April nonfarm payrolls rose
more than anticipated; the April ADP private
payroll report was up less that forecasts while weekly jobless claims were a
positive; the April index of consumer confidence was well ahead of expectations,
(3)
industry: both the April ISM manufacturing and
nonmanufacturing indices were lower than estimates; March factory orders, the
April Chicago PMI , the Dallas Fed
manufacturing index and March construction spending were very disappointing,
(4)
macroeconomic: first quarter productivity rose less
than anticipated while unit labor costs advanced smartly; the March trade
balance was well below consensus expectations; the statement from this week’s FOMC
meeting suggested that further easing was possible.
The Market-Disciplined Investing
Technical
The indices (DJIA
14973, S&P 1614) smoked this week, closing within all major uptrends: short term (14245-14962
[OK the Dow was slightly above this upper boundary], 1565-1642), intermediate
term (13858-18858, 1469-2058) and long term (4783-17500, 688-1750).
On Monday, the
S&P confirmed its break above its former all time high; then both Averages
sprinted higher for the week. Clearly,
the bulls are in control and the question is now, how high can stocks go? My bet is on the upper boundaries of the
indices long term uptrend (1750/17500); but as I noted earlier this week, my
bet has been for s**t lately.
Volume was up a
bit on Friday; breadth was mixed. The
VIX fell slightly, finishing within its short and intermediate term downtrends. It is still a positive for stocks; though as
it approaches the lower boundary of its long term trading range, a trader might
want to buy a position as a hedge.
GLD was up
fractionally, finishing within its intermediate term downtrend. Until we get a test of either the prior low
or the lower boundary of its long term uptrend, I don’t think that there is any
bet here.
Bottom
line:
(1)
the indices are trading within their short term uptrends
[14245-14962, 1565-1642] and intermediate term uptrends [13858-18858, 1469-2058].
(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 (14973)
finished this week about 31% above Fair Value (11425) while the S&P (1614) closed
13.9% 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 economy along
with the first quarter earnings season continues to track our forecast, though
admittedly a bit more erratically in the last couple of weeks. As you know, I am upbeat on the economy and I
believe in American business’ ability to grow in adversity. However, even with an improving US
economy and Europe actually being able to ‘muddle
through’, our Valuation Model just can’t get equity valuations to current
levels.
I noted above,
there is a good news aspect to the fact that (1) the media is focusing on the
positive employment numbers, ignoring the more unpleasant stats (2) while
investors are just jiggy with anything---and that is, it may make it much more
difficult for Obama to continue to poor mouth sequestration and by extension
other cuts in government spending. If
this helps push Him toward some sort of negotiated budget settlement that includes
entitlement and tax reform that would in turn change this factor from a
negative to a positive in both our Economic and Valuation Models. ‘If’ being the operative word.
Global monetary
policy remains a negative and gets more so as other central banks [ECB] join
the money printing extravaganza. While
their purpose is, of course, to
stimulate economic activity, the bottom line is that (1) if global economic
conditions improve from here, then the day the Fed/central banks must began
tightening is drawing nigh, but (2) if the global economy is deteriorating,
then we will likely see an even greater infusion of liquidity into the
financial system. While that may
postpone the drop dead date for monetary tightening, regrettably it won’t
eliminate it.
The point here
is that if history repeats itself, (1) the transition from easy to tight
[normal] monetary policy will be a negative for our Models; I just don’t know
when, (2) more importantly, neither do I know the extent of the damage that
will occur in the tightening process because we are in totally uncharted waters
and (3) as a result, this risk is not properly reflected in our Models.
With respect to
Europe specifically, whether or not its economy is or is not be getting worse,
any new monetary easing from the ECB will likely produce some short term
positive effects and would assure that our ‘muddle through’ scenario remains alive and well.
My investment conclusion: most of the assumptions in our Models are
unchanged. The developments this week
that may eventually have to be factored in are (1) continued softness in the US ,
the nonfarm payrolls number notwithstanding, (2) disappointing data out of China ,
(3) a new liquidity injection from the ECB and, (4) a potential bottoming in
the economic deterioration in the EU.
However, none of these have risen to the level that warrants amending
our Valuation Model.
Neither
is there anything that makes me want to chase stock prices further into
overvalued territory. I recognize that I
am in the unenviable position of being wrong on the Market right now; and I
hate that. But our Valuation Model has
served me well for over thirty years; so I am not going to chicken out in the
heat of battle. Indeed, one of the main
reasons that the Valuation Model was constructed was to prevent emotional
decisions at Market extremes. So while I
absolutely hate being wrong, I don’t hate it enough to risk principal by
lowering our Portfolios’ above average cash positions.
This week, the Dividend Growth Portfolio
Sold a portion of its Nike position when the stock traded into its Sell
Half Range
Why
own bonds (medium):
The
latest from Gary Shilling (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 5/31/13 11425 1416
Close this week 14973 1614
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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