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 Trading Range 14190
(?)-15517
Intermediate Uptrend 14217-19217
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 1494-2082
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 releases were relatively few and contained more positive
than negative indicators: positives---weekly retail sales, May existing home
sales, the June NY and Philadelphia manufacturing indices, May CPI
and the FOMC decision to begin tapering by year end; negatives---weekly mortgage
and purchase applications, May housing starts, weekly jobless claims and the
June leading economic indicators; neutral---none.
Of course, the
big Kahuna was the FOMC decision to begin tapering which I consider a positive
(it has encouraged speculation, penalized savers, discouraged business
investment, enabled the government to run outrageous deficits on the cheap and
done almost nothing to lift the economy); though judging by the Market reaction,
many would clearly argue with me about that.
I would suggest
that their disagreement is more Market based than economic based because (1)
QEInfinity has been the heroin that driven stock prices to levels that our
Valuation Model classifies as extremely overvalued and (2) I can’t see how a
transition from an unprecedented level of reserve injection would be a negative
if those injections had done little to improve an economy which was rebounding
for cyclical reasons anyway. To be sure,
that current growth rate is sub par by historical standards but that is a
function of lousy fiscal policy; and if anything QEInfinity has only made matters
worse.
In the meantime,
despite the best efforts of our entire ruling class to f**k things up, the
economy is performing pretty much in line with our forecast. However, I am leaving the amber light
flashing more as a result of this week’s violent Market reaction and its
potential negative implications for the global credit markets than because the
numbers are disappointing
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 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
latest from Lance Roberts (medium):
The
pluses:
(1) our improving energy picture.
The US
The
negatives:
(1)
a vulnerable global banking system. The principal news this week was mounting
credit problems in China
and several of the southern EU countries.
Indeed, there were rumors Thursday that a major Chinese bank could not meet
its overnight reserve requirements, forcing the Chinese central bank to inject
funds---‘rumors’ being the operative word.
That accompanied by Bernanke’s
tapering comments appear to have awakened
the bond vigilantes which is not good for bond prices, the yen carry
trade or the derivatives markets---all closely tied to the 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. I don’t know
that the chickens are coming home to roost here; but the last two days of
trading are pointing in that direction.
‘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.’
Nothing says
‘risk’ like inadequate bank capital (medium):
(2)
fiscal policy. Monetary
policies pushed everything else off the front pages this week. For Obama that had to be good news, because
it took voters/investors minds off both His scandal ridden administration and
the fact that there is no fiscal news, good or bad, to be overshadowed. Meanwhile, the government is still running
unsustainable deficits; and everyone in Washington
is having too much fun watching Obama scramble for His life, to do anything
meaningful to resolve our fiscal issues.
One thing to
note regarding the interplay of fiscal and monetary policies: if the Fed does
indeed start tapering later this year, then the $64,000 question is, who is
going to buy all those bonds that the Fed won’t buy? If you remember the numbers, QEInfinity is
now absorbing roughly all of the government’s
budget shortfall ($85 billion/month [QE] = $1 trillion/year [budget
deficit]. By the way, I know that half
of the QE purchases are mortgages; but the money that would have bought those
mortgages has to be invested elsewhere, e.g. Treasuries). So if the Fed is done with QEInfinity by June
2014 as Bernanke suggested, a whole lot of somebodies somewhere have to step up
to the plate in a big way to fund the government deficit. Because if they don’t, interest rates are
going to rise even more than they currently are and that means trouble with a
capital T, right here in River City---which brings me to the portion of this
section that I copy every week; and which you have probably long tired of
reading and may have even forgotten:
.....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: Bernanke set off a fire storm
this week when he outlined the Fed’s plan for tapering. Global credit markets began seizing up; bond
prices plummeted along with those of equities and commodities. So we appear to be finding out at least one negative impact of ‘central bank money
printing’. How bad this gets and whether
there are more negative impacts awaiting us, I have no idea. But we will know soon enough.
I laid out my
initial reaction in Friday’s Morning Call and nothing happened Friday to change
that:
[a] I have been
yakking about irresponsible Fed policy forever.
That doesn’t make me a bear on the US
economy; it just means that I thought that easy money had caused stock prices to
get way ahead of themselves based on the fundamentals as I see them.
[b] the
optimists are now arguing that {i} if the Fed is correct and the economy is
improving, then that will justify current stock prices, {ii} but if the Fed is
wrong, it will continue QEInfinity. To
which I reply {i} the Fed’s forecast is not that much better than our own; so
there is no way that stocks are currently priced Fairly even if the Fed’s
estimates were a lock and {ii} if the Fed is wrong, all faith will be
lost. Who in his right mind is going to
believe that the Fed will get it right the next time when it is clear that once
again it has botched the transition process---in other words, investors learn
again that ‘it is never different this time’?
[c] in my
opinion, the Fed has drawn its line in the sand. The best outcome possible is that the economy
continues to plod along, growing at a below average secular rate. If the economy stumbles and the Fed re-starts
(or never stops) QEInfinity, I don’t believe that investors will return to
their prior mindset because then they will know that the Fed doesn’t know what
it is doing---which is not an investable thesis.
Other potential
problems that could began surfacing:
[a] our banks
have used the Fed’s 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 could 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.’
(4) a blow up in the Middle East . ‘The US,
Russia Israel
(5)
finally, the sovereign and bank debt crisis in Europe . This week, both Cyprus
and Greece
returned to the brink. Downsizing
[austerity] continues to prove more difficult than imagined. Deficits are larger than estimated; so
additional funding is needed and it appears that it won’t come quite so easily
this time around. That keeps my fears
concerning excessive sovereign indebtedness and poor quality, overleveraged EU
bank balance sheets very much alive.
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.
Bottom line: the US
economy remains a positive for Your Money.
Fiscal policy is a mess and likely to stay that way as a result of the
ongoing scandals. If a stalemate in Washington
continues, so will the headwinds it is creating for the economy.
Central bank
reserve creation was finally called into question this week, precipitated by
Bernanke’s post FOMC meeting comments. It is too soon to know exactly how this game
ends, though in my opinion, the best scenario possible is our current
forecast. Clearly, if that is the best
that can happen, worse is possible.
Finally, Europe
remains a problem and it is not getting any better as witnessed by this week’s
news out of Greece
and Cyprus . If credit markets continue to seize up,
sooner or later it will visit the EU sovereigns and that would spell trouble.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications declined;
May housing starts were up less than estimates, while May existing home sales
were very strong,
(2)
consumer: weekly retail sales were up; weekly jobless
claims rose more than forecasts,
(3)
industry: both the June NY and Philadelphia Fed
manufacturing indices were much stronger than anticipated,
(4)
macroeconomic: May CPI
was slightly below expectations as were the May leading economic indicators;
the Fed suggested that tapering would start sometime near year end.
The Market-Disciplined Investing
Technical
It was a lousy
week in stock land (DJIA 14801, S&P 1592).
Both indices have broken below their short term uptrends and their 50
day moving averages. They are now in a search
for the lower boundaries of a new short term trading range but remain within
their intermediate term (14217-19217, 1508-2096) and long term uptrends (4783-17500,
688-1750).
On Friday, volume
soared but that was a function of option expiration; breadth improved slightly. However, the end of week bounce was pretty
pathetic given equities extreme oversold
condition. The VIX broke out of its
short term downtrend and is now looking for an upper boundary of a new trading
range. This is not a positive for
stocks. It remains within its
intermediate term downtrend.
GLD got pummeled
and took out the double bottom and, more importantly, the lower boundary of its
long term uptrend. It will now be
searching for a lower boundary of a new long term trading range, In the meantime, it is in short and intermediate term downtrends. The technical damage to this chart is
enormous.
Bottom line: another
recent Market thesis (buy the dips) was destroyed this week. Stocks are now broken, at least on a short
term basis and will be searching for support.
There is nothing to do but watch the process.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (14801)
finished this week about 29.2% above Fair Value (11450) while the S&P (1592)
closed 12.2% 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.
Two of those
assumptions remain on target: (1) the economy continues to grow at a sluggish
pace and (2) our ruling class’ half assed’ fiscal policy is being defined by
the sequestration and 1/1/13 tax increase.
As much as I would like to believe these clowns will do something more,
I think it unlikely, at least in the near term,
Clearly
Bernanke’s description of the tapering process was the Market moving item of
the week and raises doubts about the ‘continued money printing’ portion of our
forecast. However, I can’t offer an
alternative until we get the answers to a couple of questions: (1) will the Fed
follow though with stated game plan and actually transition to tighter money,
(2) if they chicken out for whatever reason, will the Markets retain/regain its
faith in the Fed and (3) of immediate importance, has the Market had an
‘emperor’s new clothes’ moment and decided that it will no longer buy central
bank paper without extracting a substantial risk premium for doing so. As I have said, it is too soon to tell. But we do know that the next couple of weeks
will be interesting.
Finally, after
several months in the shadows, our EU ‘muddle through’ scenario may get another
challenge in the upcoming weeks, if the credit markets continue in
turmoil. Given that the eurocrats did nothing
in the recent respite to address sovereign and bank debt problems, I am less
hopeful that our assumption will prevail.
That said, remember that the ‘muddle through’ scenario includes a Greek
exit from the EU.
Bottom line: two of the key assumptions in our Models are
unchanged---economic growth and an inept fiscal policy. On the other hand, monetary policy appears
about to change. I like what the Fed has
proposed, but the issues are, will it go through with tapering, how much will that
impact economic growth, how will that impact the consensus forecast for
economic growth and how painful will the period of investor detox be.
In addition, our EU ‘muddle through’ assumption is apt to be
tested if the aforementioned investor detox gets hairy and credit markets
suffer any further severe dislocations.
On both monetary policy and the EU ‘muddle through’ assumptions, it is
too early to get a sense of how the end game plays out. Clearly, the amber light is flashing and may
be a short hair away from turning red.
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 14801 1592
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.
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