The Closing Bell
I am taking next week
off. I will return July 8. As always I will be monitoring the Market and
if action is needed will be touch via Subscriber Alerts
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
2.2%
Inflation
(revised): 1.8 %
Growth
in Corporate Profits: 16.1%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 1.5-2.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 14190
(?)-15517
Intermediate Uptrend 14254-19254
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 Trading Range 1576 (?)-1687
Intermediate
Term Uptrend 1511-2099
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 42%
High
Yield Portfolio 44%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. It was
a relatively busy week for economic releases and contained more positive than
negative indicators: positives---May durable goods orders, the Dallas and
Richmond Fed manufacturing indices, weekly purchase applications, May new home
sales, the April Case Shiller home price index, May personal income and June
consumer confidence and sentiment; negatives---weekly mortgage applications, May
personal spending, the Chicago National Activity Index, June Chicago PMI ,
first quarter GDP and corporate profits; neutral---weekly
retail sales and weekly jobless claims.
The numbers over
the last couple of weeks have been weighted to the plus side, reversing the
April/May trend towards economic weakness.
That suggests that I should turn off the flashing yellow light on the
economy. However, I am leaving it on
because (1) Obama has decided to attempt to overhaul the US energy policy,
which, as fate would have it, is the one solid positive in our economic outlook
and (2) despite the confusion wrought by Bernanke’s ‘tapering’ comments and the
subsequent full court press to walk back that statement, investors are starting
to question their faith in Fed policy,
which, in turn, is causing turmoil in the credit markets.
I am, however, altering our forecast somewhat, eliminating
the concern about inflation but leaving the risk of the Fed improperly timing
its transition in policy. 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 historic inability of
the Fed to properly time the reversal of a vastly over expansive monetary policy.
A
turd in the punch bowl (medium and a must read):
The
pluses:
(1)
our improving energy picture. The US
Regrettably as
I noted above, Obama has once again put ideological issues above the economic
well being of the country. His attempts to
dismantle the coal industry and obstruct the completion of the Keystone
pipeline will negatively impact the national security of the country in the
long term as well as adversely affect our struggle to solve the unemployment
problem in the short term.
The
negatives:
(1)
a vulnerable global banking system. The principal news this week was mounting
problems in Europe ; specifically, the revelation of huge
potential derivative losses in Italy
and the deterioration in the French financial system.
As to the former, those derivative transactions were originally set up to
mask the lousy state of the Italian budget when it was applying for membership into the EU.
We already know that the Greek government engaged in the same type
transactions; so the question is, how many more countries employed the same
tactics and hence have large and to date undisclosed derivative losses?
In addition,
the EU announced that the Cyprus
template [bank depositors share in losses in case of insolvency] will now apply
to all of Europe .
What do think that means for capital outflows from the EU banking
system?
As you know,
one of my primary concerns has been the lack of transparency in the derivatives
markets which I believe carries [and recent trading desk explosions confirm]
considerably more risk than assumed by traders, quants and anyone else foolish
enough to be chasing yield.
‘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. Our
ruling class continues to focus on everything but getting control of the
federal budget. This week it was on [a]
the Senate’s immigration bill, in which one result will be to add lots and lots
of potential Democratic voters to the welfare rolls that Your Taxes will fund
and [b] as I noted above, an Obama overhaul of energy policy which will {i} increase
unemployment, {ii} drive up electricity costs in coal burning states (oddly
most of which are red states) and {iii} reduce the chances of the US becoming
energy independent anytime soon. Well
done, Mr. President, well done.
In short,
entitlement and tax reform remain a wet dream, the economy must still fight
this fiscal policy headwind and the Fed will continue to assume that it alone
must bear the responsibility of keeping the economy from falling back into
recession---an assumption that has led to policy moves more harmful than
helpful to the economy.
I also continue
to worry 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)
the potential negative impact of central bank money
printing: The key point here is that [a]
the Fed has inflated bank reserves far beyond any comparable level in history
and [b] while this hasn’t been an economic problem to date, {i} it still has to
withdraw all those reserves from the system without creating any
disruptions---a task that I regularly point out it has proven inept at in the
past and {ii} it has created or is creating asset bubbles in the stock market
as well as in the auto, student and mortgage loan markets.
Unfortunately,
other central banks have followed the Fed’s lead; hence the problem is not
confined to this country, but rather has become a global one. From the outset, I have maintained that this
experiment was not going to end well; and we got a hint of that in the prior
week when Japanese and Chinese credit markets were seizing up. Banking officials from around the world spent
the past week walking back hawkish policy statements that had originally caused
those credit market problems. That may
prove to be a temporary salve; but it doesn’t change that fact that tightening
has to occur sometime, it will likely not be a pleasant experience and the
Markets, which have become addicted to easy money, will have to adjust---and
indeed may have already started that process.
An analysis of
why past credit crunches occurred and why it will happen again (medium and
today’s must read):
And this great
article on why deflation is not so bad (medium and another must read):
It’s never a
good time to tighten (medium):
More from China
(medium):
And this great
explanation of what is occurring in China
(medium and a must read):
Finally, 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.’
(4) a blow up in the Middle East . ‘The US,
Russia Israel
(5)
finally, the sovereign and bank debt crisis in Europe . There was mixed news out of Europe
this week. On the negative side as noted
above, it appears that Italy could incur billions in losses in the derivatives
market, France’s budget deficit is growing not shrinking and its banks are
weakening not strengthening and the ECB has decided that the Cyprus template
rules.
On the other
hand, the EU agreed to cut its budget deficit and rumors abound that the ECB
will follow the US
and Japan down
the road of government bond purchases [monetary easing]. The former is the first concrete step in some
time that the eurocrats have taken to address the mess that they created. Whether or not they follow through with it is
another issue. But, credit where credit
is due, it is a positive step. That
said, whether it is not too late to do any good remains to be seen. Certainly, it doesn’t assuage my concerns
over the risks associated with excessive sovereign indebtedness and poor
quality, overleveraged EU bank balance sheets.
‘To be sure, Europe has managed to ‘muddle through’ so
far---indeed that has been our forecast. But if current turmoil in the credit and
derivatives markets continues, the EU economies, in particular those weak Mediterranean
sisters, are much more vulnerable as a result of the magnitude of their indebtedness
and overleveraged banks.’
Merkel not happy with the Irish (short):
Bottom line: the US
economy remains a positive for Your Money but primarily as a result of the hard
work and genius of American businesses and workers. Fiscal policy reform has taken a back seat to
scandals, immigration and energy policies.
So the restraints caused by irresponsible spending, inefficient taxing
and over regulation will continue to hold back the economy from returning to
its average historical, secular growth rate.
Central bank
reserve creation policies have turned into a clusterf**k. First the US and Chinese banks actually
started to do the right thing; the Markets understandably swooned when they
realized the punch bowl was being taken away and now the central bankers are
stumbling all over themselves to walk back their original statements/actions.
However, as you know, I think that the jig is up in that Markets no longer
accept that QEInfinity can go on forever with no negative consequences. If I am correct, this will impact the economy
via higher interest rates---another drag on growth.
Finally, Europe
remains a problem. Even if the ECB buys
sovereign bonds, I doubt that will be sufficient of overcome the turmoil that
could flow from rising sovereign and bank derivative losses.
This week’s
data:
(1)
housing: weekly mortgage applications declined while
purchase applications rose; May new home sales were up more than expected; the
April Case Shiller home price index was very strong,
(2)
consumer: May personal income rose more than estimates
while spending was up slightly less; weekly retail sales were mixed; weekly
jobless fell, in line with forecasts; June consumer confidence was up more than
anticipated as was June consumer sentiment,
(3)
industry: May durable goods orders were stronger than expected;
the Chicago Fed National Activity Index was down more than estimates; the June
Chicago PMI came in at 51.6 versus forecast
of 55.0 and May’s reading of 58.7, the June Dallas and Richmond Fed
manufacturing indices were much better than anticipated while the Kansas City
Fed index was very disappointing,
(4)
macroeconomic: revised first quarter GDP
was well below forecasts; fourth quarter corporate profits were considerably
below those reported in fourth quarter 2012.
The Market-Disciplined Investing
Technical
The Averages (DJIA
14905, S&P 1606) had a good week, though Friday was down Last week, both indices broke their 50 day
moving averages (intersect circa 15025, 1619); this week they rallied
sufficiently to challenge this resistance level on Thursday, but fell back on
Friday.
This pin action
also served to set what may be another lower high in the downtrend off the May
22 high. I say ‘may be’ because the Averages on Friday were
basically flat with their Thursday close going into the last fifteen minutes of
trading---which was heavily influenced by the ‘Russell rebalancing’ on the
close (index funds mirroring the Russell indices re-set their composition quarterly
based on additions to and subtractions from those indices). The point here is that had the Dow and
S&P closed flat on Friday, there would have been no new lower high, simply
a pause in an uptrend. This isn’t a
particularly big deal and Monday’s trading will resolve the issue, But I point it out as something that I will
be paying close attention to on Monday.
That said, the
Averages continue to trade in a downtrend off their May 22 high (intersect
circa 15254, 1640), to search for a lower boundary of a new short term trading
range (14190 [?]-15550, 1576 [?]-1687) and to remain within their intermediate
term (14254-19254, 1511-2099) and long term uptrends (4783-17500,
688-1750).
On Friday, volume
soared but, as I noted above, that was largely a function of the ‘Russell
re-balancing’; breadth deteriorated. The
VIX was off fractionally closing within its intermediate term downtrend and
still looking to set an upper boundary of a short term trading range. It also remains above a very short term
uptrend, which if broken would be a positive for stocks.
Margin debt
posts first monthly decline in a year (short):
GLD actually had
an up day, surprise, surprise. However,
it closed outside the boundaries of all major trends. This is a sick puppy.
Bottom line: equities
had a nice rally this week; but not sufficient enough to call into the question
the very short term downtrends of the Averages as well as a preponderance of
the stocks in our Universe. On Monday if
the indices reverse Friday’s decline and subsequently challenge their 50 day
moving averages, that would signal the sell off could potentially be over. There is nothing to do but watch the process.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (14905)
finished this week about 30.1% above Fair Value (11450) while the S&P (1606)
closed 13.1% overvalued (1419). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe.
Two of those
assumptions remain on target: (1) the economy continues to grow at a sluggish
pace and (2) our ruling class would rather focus on ideological issues than budgetary
ones.
The ‘tapering’
debate remained front and center this week, kept there as it was by an endless
stream of Fed officials attempting to walk back Bernanke’s statement. However, I think that all the discussion
about what levels of unemployment and inflation would trigger ‘tapering’ and
their likelihood misses a critical point; and that is, that Markets have come to
realize that the Fed’s easy money policy has already created asset bubbles that
will burst sooner or later and hence, the risk premiums in all asset classes
are going up. In other words, the
specifics of Fed guidance on policy matter much less than a week ago because
the end result (increased risk premiums) is going to/or already is happening no
matter it does. To be clear, this is
just my hypothesis on what is and will happen going forward and, therefore,
subject to being wrong.
Finally, bad
news continues to emanate out of Europe ; though to be
fair, the reported EU agreement to reduce its budget deficit is a positive
assuming the eurocrats actually implement it. That action notwithstanding, the
risks of a sovereign and/or banking debt crisis remain a threat to our ‘muddle
through’ scenario.
Bottom line: our key assumptions in our Models on economic
growth and an inept fiscal policy are unchanged. Monetary policy may or may not be changing;
but whatever happens, I believe that investor attitudes about monetary policy are
changing---becoming more skeptical of Fed omnipotence and altering the
stability in the credit markets.
Finally, if more volatility is coming to the fixed income markets, the
risk of dislocations in the European sovereign and bank debt markets rises.
This week, our Portfolios did nothing.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 6/30/13 11450 1419
Close this week 14905 1606
Over Valuation vs. 6/30 Close
5% overvalued 12022 1489
10%
overvalued 12595 1560
15%
overvalued 13167 1631
20%
overvalued 13740 1702
25%
overvalued 14312 1773
30%
overvalued 14885 1844
Under Valuation vs.6/30 Close
5%
undervalued 10877 1348
10%undervalued 10305 1277
15%undervalued 9732 1206
* 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.
