The Closing Bell
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 Uptrend 14612-15320
Intermediate Uptrend 14028-19028
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 1600-1677
Intermediate
Term Uptrend 1488-2076
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. This
week’s economic data was basically mixed: positives---weekly purchase
applications, May Chicago PMI , the March Case
Shiller home price index and both May consumer confidence and consumer
sentiment numbers; negatives---weekly mortgage applications, April pending home
sales, weekly jobless claims, April personal income and spending, the May
Dallas Fed manufacturing index; neutral---weekly retail sales, the May Richmond
Fed manufacturing index and revised first quarter GDP ,
price deflator and corporate profits. So
the data continues to roughly reflect our forecast; however, I am leaving the amber light flashing.
‘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
And:
The
negatives:
(1) a vulnerable
global banking system. This week the
Bank of International Settlements warned global central banks about bank
lending practices [cough, leverage, cough, cough, derivatives]. I linked to a detailed explanation in
Thursday’s Morning Call.
And (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. While a
scandal ridden administration makes for juicy headlines and fodder for the late
night comics, it provides the ruling class an excuse to avoid doing the right
thing---entitlement and tax reform.
On the other
hand, with the sequester and tax hikes doing their job [reducing the deficit],
the Washington morality play
takes the ruling class’ attention off the any effort to reverse them. Furthermore, new
administrative/regulatory overreaches
are surfacing almost every day---the cumulative impact of which may have Obama
grasping for a life jacket in any from to save His government/legacy. And nothing saves better than a ‘grand bargain’. That, of course, may be wishful thinking in
extreme; but, at the least, a wounded Obama will have a lot less leverage in
negotiating entitlement, tax and healthcare reform.
All that
aside, US
government debt continues to grow and that means that the risk is also
increasing of 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 may address the twin long term budget problems
of entitlement spending and tax reform which if successful would turn fiscal
policy into a positive for the economy.
However, I am not betting any money on it.
(3)
the potential negative impact of central bank money
printing: as you may have noticed, I altered the title of this section from
‘inflation’ to the above. The primary
motivating factor is the current turmoil in the Japanese markets where its
central bank’s expansive monetary policy may be starting to come
unraveled. [the operative words being
‘may be’] and inflation is nowhere is sight.
As you know, I
have long held that the transition of central bank monetary policy from ease to
tightening would result in either recession or inflation; and my bet was on
inflation. However, if the birds are
indeed coming home to roost in Japan ,
it is not immediately apparent that inflation is a foregone consequence. In fact, economically speaking, I am not sure
what is occurring; or perhaps better said, I am not sure what is going to occur
if investors continue to drive interest rates up.
On the other
hand, I have also said that we are in uncharted waters. So perhaps that renders my prediction of
inflation in a transition period more suspect than I would have thought a week
ago. My point is whether or not, the current
collapse in Japanese bond prices turns out to be the first step in unwinding
QEInfinity, it forces me to acknowledge that I am less certain that the end
result will be inflation. Indeed, I
lowered our inflation forecast for 2013 from 2.5-3.5% to 1.5-2.5%.
That by no
means should be interpreted as inferring that the transition from easing to
tightening will be any less painful. It
simply means that I am not sure that the end result will be inflation. It could be recession; and indeed it could be
both.
Other potential
problems flowing out of the current massive injection of liquidity are:
[a] 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,
[b] 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.
(4) a blow up in the Middle East . The US, Russia
and Israel
continue to lay down markers in the Syrian civil war. As each side gets less flexible in its
position, I worry 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.
And (medium):
(5)
finally, the sovereign and bank debt crisis in Europe . This week, the data flow out of the EU stayed
negative. Unfortunately, given the
level of sovereign indebtedness, the overleveraged European bank balance sheets
and the [low] quality of the assets on those balance sheets, the EU economy is
much more susceptible to minor changes in growth than in the US.
To date, the EU
has held together and the banking system
remained nominally solvent [‘muddled through’] largely as a result of the ‘do
anything necessary’ policies of the ECB; and clearly, there is some probability
that the ‘muddle through’ scenario will continue to be operative. However, if QEInfinity is coming to an end,
this could cause economic problems for the sovereigns [less growth] and
liquidity problems for the banks. If
that proves to be the case, then ‘muddle through’ would likely meet its end.
Bottom line: the US
economy remains a positive for Your Money.
Fiscal policy is uncertain. If we
can get entitlement and tax reform, it would be a positive. On the other hand, if the political class
does nothing except pursue its internecine brawl, fiscal policy will remain a
drag on the economy.
Central bank
reserve creation continues in overdrive, though the current turmoil in the
Japanese bond market could be signal that this is all coming to an end. If so, I am uncertain about the magnitude of
the fallout for the simple reason that the US
and global economy has never experienced money creation on the current
scale. My guess is that this is not
going to end pretty and some adjustment to our Model will be necessary.
Finally, Europe
remains a problem. Its economy is
deteriorating. Meanwhile, the eurocrats
have done nothing to lower the level of sovereign debt or improve highly
overleveraged bank balance sheets. That
is a combustible combination. True, Europe
is and may continue to ‘muddle through’; but not because any attempt has been
made to fix the underlying problems.
This week’s
data:
(1)
housing: weekly mortgage applications declined while
purchase applications were up; April pending home sales increased less than
forecast; the March Case Shiller home price index rose more than anticipated,
(2)
consumer: weekly retail sales were mixed; both the
April consumer income and spending numbers were a disappointment; May consumer
confidence was quite strong and the final May University of Michigan index of
consumer sentiment was ahead of forecast; weekly jobless claims were higher
than estimates,
(3)
industry: the May Chicago PMI
came in much stronger than expected; the May Dallas Fed manufacturing index was
weaker than forecast, while the Richmond ’s
index was down less than estimates,
(4)
macroeconomic: revised first quarter GDP
growth rate was slightly less than forecast and so was the deflator, while
corporate profits showed an marked slowdown in growth.
The Market-Disciplined Investing
Technical
The indices (DJIA
15118, S&P 1630) kept up their recent see saw behavior closing down big on
Friday. Nevertheless, they remain within
all their major uptrends: short term (14612-15320, 1600-1677), intermediate
term (14028-19028, 1488-2076) and long term (4783-17500, 688-1750).
Volume was up
big time though much of that was attributed to index fund rebalancing; breadth declined. The VIX surged. It remained within its short and intermediate
term downtrends; although it is nearing the upper boundary of its short term
downtrend.
GLD dropped,
reversing the upside break in Thursday’s pin action---which keeps our
Portfolios on the sideline. However, it
finished above the recent double bottom and the lower boundary of its long term
uptrend.
Bottom line: one
bad day doesn’t make a change of trend.
So I am hesitant to make too much of Friday’s pin action. That said, following last Wednesday’s
‘outside down day’, the Averages have been unable to regain any sustained
upside momentum. The ‘buy the dippers’
are certainly still out there. However,
they failed to drive prices to new highs for the first time in a long
time. Let’s see how well they do next
week. The critical level they most over
come is 1675 in order to negate the impact of that ‘outside down day’.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15168)
finished this week about 32.4% above Fair Value (11450) while the S&P (1630)
closed 14.8% overvalued (1419). 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.
Monetary policy held
the spot light this week in the form of turmoil in the Japanese bond market and
an expanding debate regarding Fed ‘tapering’.
As you know, this is one of my chief concerns; specifically because (1) the
massive global expansion of liquidity is unprecedented; and therefore, it is
likely that the unwinding process will also be unprecedented and (2) Fed has
never, ever, ever successfully transitioned from easing to tight money policy. The point here is that transition process may
be starting prompted by bond investors’ unwillingness to hold and buy endless
amounts of Japanese bonds and the heightened anxiety in the US
regarding Fed ‘tapering’.
Regarding the
latter, yesterday the economic news was reasonably positive (strong Chicago PMI ,
upbeat consumer sentiment), yet the pin action was awful, seemingly suggesting
that QE is a lot more important to investors than a good economy. Meaning that
if the monetary party is ending, this up Market may be over.
So the $64,000
question is, is it indeed crunch time for the Fed? Will it start a transition and if it does,
will it be too much or too little?
Unfortunately, as noted above, policy is so far into the unknown, Bernanke
has little historical precedent to rely on even if he thinks he knows how to
bring about a successful end game.
From the minutes
of a Fed policy meeting (short but a must read):
Net, net, if
history repeats itself with monetary policy now in uncharted waters, the
transition from easy to tight [normal] monetary policy will likely be a bigger negative
for our Models than is currently reflected; I just don’t know by how much.
Bottom line: most of the assumptions in our Models are
unchanged; though that of monetary policy almost assuredly will, the
alterations will most likely be to the negative and they may happen sooner than
I would have thought a week ago.
Certainly nothing has occurred that
improves equity valuations or persuades me to buy stocks are current price
levels.
In fact, this week, the Dividend
Growth Portfolio Sold Half of its Tiffany holding and the High Yield Portfolio
Sold the remainder of its Pioneer Southwest Energy Ptrs position.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 6/30/13 11450 1419
Close this week 15118 1630
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
35%
overvalued 15457 1916
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.
No comments:
Post a Comment