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 14190-15550
Intermediate Uptrend 14364-19364
Long Term Trading Range 4918-17000
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 1527-2115
Long
Term Trading Range 715-1800
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 43%
High
Yield Portfolio 45%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. This week’s
economic data was definitely upbeat: positives---weekly purchase applications,
the NAHB home builders index, weekly jobless claims, June industrial
production, the June NY and Philadelphia Fed manufacturing indices, June CPI
and the Fed Beige Book; negatives---weekly mortgage applications, June housing
starts and June retail sales; neutral---weekly retail sales and June leading
economic indicators.
The numbers continue
to track with our outlook. However, I
again leave the yellow light flashing because of the confusion generated over
‘tapering’. Granted Bernanke is in full
retreat; and whether or not investors face the facts, businesses and consumers
saw the surge in interest rates following Bernanke’s initial comments. That could keep them very guarded and perhaps
even hesitant to proceed with any investment or spending plans already on the
books. So until we get a better sense of
their reactions to this melodrama, the caution flag is up. 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.
Update
on big four economic indicators:
The
pluses:
(1)
our improving energy picture. The US
The
negatives:
(1)
a vulnerable global banking system. The political situations in Portugal
and Spain
continue to deteriorate. Italy ’s
budget deficit is growing relentlessly. While the Greek parliament agreed to
the latest austerity demands of the ECB in order to get its next liquidity
injection, the electorate is once again in the streets. And on this side of the pond, it looks like
JP Morgan will eat a $500 million fine for fraud in its trading unit---similar
to the HSBC’s sentence last week.
On the other
hand, US banks are reporting improved earnings aided by a decline in reserves
for bad loans which were set up back in 2008.
I won’t argue with the notion that bank balance sheets are healing.
My problem is
that we still don’t know [a] just how bad the loans losses are that remain on
the balance sheets, [b] how much new risk has been assumed in the major banks
prop trading desks, [c] anything about the condition of the EU bank balance
sheets except that they are lousy with sovereign debt and [d] what US banks’
counterparty risk exposure is to those EU banks.
That lack of
visibility keeps the stability of the global banking system high on our list of
risks
‘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. Keeping
the positive trends in this area in tact, the house voted this week to delay
the implementation of the individual and employee mandates in Obamacare.
That said,
‘delaying the implementation’ of Obamacare doesn’t make it go away and turn the
long term into a rosy scenario; nor do the benefits of an improving economy
[declining safety net costs and rising tax receipts] negate the headwinds posed
by an entitlement system that is completely out of control and a tax system
that is corrupt and inefficient.
Unfortunately,
entitlement and tax reform remain as elusive as ever which leaves the economy struggling
to overcome a fiscal policy headwind and the Fed assuming 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.
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.
This week
Bernanke continued his peace offense with the Markets, ‘clarifying’ in
testimony before congress that ‘tapering’ was not on a fixed schedule but
rather was ‘data dependent’ and that ‘tapering’ most assuredly wasn’t
‘tightening’. As you know, I have
viewed this full retreat from ‘tapering’ with a jaundice eye because:
[a] first and
perhaps foremost, save for QE1, which I will stipulate greatly aided in
preventing a melt down of the global financial system, there is hardly a
scintilla of evidence that the subsequent QE’s have done anything to improve
the economy. Indeed, it seems that the
only noticeable impact has been to push stock prices higher. The Fed’s mandate is to focus on employment
and inflation, not stock prices. Hence,
the Fed should be crawfishing on ‘tapering’ only if it believes that ‘tapering’
will negatively impact employment or inflation,
[b] given the
Market’s reaction to the initial ‘tapering’ comments, we know that investors
will react negatively when it happens. If investors don’t like it now, how much
more will they dislike it three, six or twelve months from now? More
importantly, investors now know how stocks and bonds will react to ‘tapering’;
so it stands to reason that they have to be adjusting their risk/reward models
accordingly,
[c] given this
whole ‘tapering’ episode, we/investors also know that the Fed has already made
its first mistake in its transition from easy to tight monetary policy---proving
my point that these guys, despite their best efforts, are not omniscient; that
is why the Fed has always been inept at the transition process. Unfortunately, this time around QEInfinity is
in uncharted waters, raising the risk that the move to tight money will be even
more disruptive than in the past; and the longer the Fed is cowered by the
Markets and keeps adding reserves, the worse the end game is likely to be.
[d] Fed claims
notwithstanding, ‘tapering’ {slowing bond purchases} is ‘tightening’ {raising
the Fed Funds rate}. When the Fed starts
‘tapering’ whether it is outright sales or allowing the bonds in its portfolio
to mature and not reinvest the funds, the result is still the same. New Market participants must now either buy
the bonds sold or refinance the debt being ‘rolled over’. {unless you believe that the government will
cease borrowing any new money, in which case I have a bridge in Brooklyn
I’d like to sell you}. Since those new
buyers will likely have a far different risk/reward model than the Fed, it is
highly likely they will demand higher rates to finance that debt. In other words, interest rates will
increase---a very close cousin to the Fed definition of ‘tightening’ {a higher
Fed Funds rate}. In the end, it won’t matter what the Fed Funds rate is, if
investors demand higher rates on everything else.
Bottom line: my
thesis has been that Fed will repeat its past mistakes and botch the transition
from easy to tight money. It reinforced
that notion with its bungling of the ‘tapering’ affair and attempting to
wordsmith its way out of it by differentiating ‘tapering’ from ‘tightening’. The only difference between the latest half
assed effort at transitioning and the next will be that the
Fed’s massively bloated balance sheet will be even more bloated.
More from Lance
Roberts on the Fed and the liquidity trap it has created (medium and a must
read):
QE, growth,
cause and effect (medium and also a must read):
(4) a blow up in the Middle
East . Egypt
seems to have settled down for the moment and Syria
is quiet, though there was a press release this week that Obama is considering
addition measures against the Assad regime.
Nevertheless, the region remains volatile, so potential disruptions in
supply or transportation continue to be a threat to prices---which can in turn
influence economic growth of heavy energy consuming economies.
(5) finally, the sovereign and
bank debt crisis in Europe . Southern Europe
continues its slide: the Greek parliament voted for new austerity measures in
order to get the next round of its bail out which prompted more rioting, while Portugal
and Spain
remain burdened by political turmoil that hampers the addressing of their
troubled economies.
Yet despite the
steady stream of bad news, southern EU countries have all managed to limp along
aided only by a few half assed fiscal measures and a lot blustery
rhetoric. That is the very definition of
‘muddling through’. One could argue that
this can go on forever, except for one point---the economies of these countries
continue to deteriorate. That means
that the risks rise that one or more, sooner or later will not be able to meet
its sovereign obligations---which is bad enough. But given that the indigenous banks are
heavily levered with their parent country’s debt, the financial systems are
also at risk.
Unfortunately,
we still have no clue how much our own banks are exposed as counterparties to the EU debt fest.
Bottom line: the US
economy continues to track with our forecast.
The good news is that fiscal policy is creating less of a drag than it
was a year ago, though much must be still done to remove this factor as
negative to growth.
The bad news is
that (1) Bernanke wouldn’t stand up to the Markets and began exiting QEInfinity
despite the lack of evidence that it is economically beneficial. This will likely make any future ‘tapering/tightening’
more painful than it otherwise might have been and (2) Europe has still taken
no measures to deal with its sovereign and bank debt problems even as economic
and political conditions in the southern EU countries grow worse.
Global business
confidence declines (medium):
This week’s
data:
(1)
housing: weekly mortgage applications declined, while
purchase applications rose; June housing starts plunged but many pundits
questioned the numbers; The NAHB Home Builders Index was very positive,
(2)
consumer: weekly retail sales were mixed while June
sales of major retailers were very disappointing; jobless claims fell more than
forecast,
(3)
industry: June industrial production was above
estimates; the NY and Philly Fed manufacturing indices were much stronger than
anticipated,
(4)
macroeconomic: June leading economic indicators were
flat; June CPI was slightly hotter than
expected; the most recent Fed Beige Book was generally upbeat.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15543, S&P 1692) had another great week.
The S&P busted through the upper boundary of its short term trading
range (1576-1687). This challenge will
be successful if the S&P can remain above 1687 though the close on Monday. However, the DJIA has not penetrated its
comparable upper boundary (14190-15550).
That puts the Averages out of sync.
For the Market to be deemed to re-set to an uptrend both of the indices
must have broken to the upside.
However, they
closed well within their intermediate term (14364-19364, 1527-2116) and long
term (4918-17000, 715-1800) uptrends.
Volume on Friday
was up; breadth was down. The VIX closed
13% lower; it has negated the very short term uptrend and is approaching the
lower boundary of its short term trading range.
GLD gained; but
its chart looks as sick as ever.
Bottom line: the
challenge of the 15550/1687 is in process, with the S&P having traded above
its short term trading range’s upper boundary for two days and the Dow still
struggling to successfully assault its comparable level. As you know, under our time and distance discipline,
breaking a trend is a process not an event..
In this case, the S&P must continue to trade above 1687 though
Monday’s close to confirm the break via the time element and the DJIA must
complete a similar exercise to confirm an overall change in the short term
Market direction.
If successful, because
the Averages would then be at all time highs, there exists no overhead
resistance save the upper boundaries of the three major trends (S&P short
term---1750, intermediate term---2116, long term ---1800).
Assuming the
1750/1800 (short and long term upper boundaries) area represents the zone of
maximum upside, that is about 3-6% versus 6% downside if stocks return to the
short term lower boundary, 9% if they slide to the intermediate term lower
boundary, 18% if they return to Fair Value and 57% if they make it all the way
to the long term lower boundary
If the
15550/1687 levels hold, the risk exists that a double, even a triple top will
have been put in.
There is nothing to do but watch the process.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15543)
finished this week about 35.4% above Fair Value (11475) while the S&P (1692)
closed 18.9% overvalued (1422). 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.
The economy
continues to perform in a very encouraging way.
The little bit of weakness that we witnessed eight to twelve weeks ago
is long gone. So that assumption carries
good confidence.
Fiscal policy is
improving in a half assed sort of way; that is, the deficit is shrinking as a
result of economic growth, the sequester and the tax hikes; and Obamacare is on
life support. On the other hand, there
seems to be little hope of entitlement or tax reform before November 2014. So I rate this assumption as less negative on
a short term basis but little changed long term.
Monetary policy
is poor and getting worse. First the Fed
backed off of the proposed move toward ‘tapering’ for no reason other than the
Markets whined a lot. As I have noted previously,
I don’t think that QE II and beyond have done much if anything to improve the
economy. Although clearly they helped
push stock prices higher. While
investors have been euphoric about that move up, I question whether it is a plus
for the Market’s health to have stock prices determined by the amount of money
that can be borrowed cheap and invested in stocks versus more fundamental
factors.
Second, the mere
fact that the Fed announced ‘tapering’ and quickly retreated supports my oft
stated notion that the Fed is considerably less wise than investors want to
believe and, therefore, it has and likely always will fail at the transition
from easy to tight money. The bigger the
Fed’s balance sheet is when it starts that process, the more painful the
outcome is likely to be.
Third, I think
the whole bulls**t routine the Fed went through trying to differentiate
‘tapering’ from ‘tightening’ only confuses the transition process further and
was a disservice to investors.
My take is that (1)
short term, the ‘tapering’ affair has chastened investors and that will make
equities progress further into overvalued territory more difficult and (2) the Market is still faced with the ever
strengthening headwinds of either spiking inflation (if the Fed tightens too
slowly) or another recession (if it tightens too fast) plus the uncertainty of
how the stock, student loan, auto loan bubbles dissipate.
However, with
respect to (1) above, it appears that I will be proven wrong. Investor behavior over the last two weeks
suggests that they are eager to take advantage of the Fed’s largess and willing
to continue to use that money to ‘chase yield’.
I am less
worried about that than I am about the potential that I am doing something
wrong in our Valuation Model. So far
events have unfolded pretty much on script: as the Market rises, our Valuation
Model starts identifying stocks that have reached their historical absolute and
relative high valuations, our Portfolios Sell Half, their cash position builds,
the Market keeps stretching valuations, our Portfolios keep Selling Half and
then the dam breaks and the Market adjusts stock valuations back to more normal
levels. That hasn’t happened yet; and
the longer it doesn’t happen, the more I have to question both the assumptions
and mechanics of our Model---which I do daily.
Maybe it truly
is different this time.
The technical
argument on why things are fine (must read):
The fundamental
argument for why you should be concerned (must read):
Finally, bad
news continues to emanate out of Europe ; so the risks of
a sovereign and/or banking debt crisis remain a threat to our ‘muddle through’
scenario.
My bottom line hasn’t changed from last week: ‘our main
issue today is, is there any changes warranted in our investment strategy
should Fed induced euphoria return and stocks shoot the moon? Or less dramatically put, what happens if
stocks break out to the upside, driven as it were by more punch?
(1) our Valuation Model hasn’t changed, so
neither have the Fair Values of the stocks in our Portfolios. To be sure, we have a few names on our Buy
Lists. But our Portfolios already own
full positions in most. I am going to
leave the remainder at less than full positions because of the simple
risk/reward equation that I cited above.
But for an investor that just has to put money to work, use our Buy
Lists,
(2) if any of our stocks trade into their Sell Half Ranges
(3) for anyone wanting to push out on the
risk curve: [a] if 15550/1687 hold and prices roll over, simply buying the VIX
(VXX) is a good alternative as well as the Ranger Short ETF (HDGE) and [b] if
stocks rocket upwards and you have to play, a good multi asset class ETF (IYLD)
would be a less risky way to participate; the Russell 2000 ETF (IWO) would be
the more risky alternative. A purchase
of any of these alternatives should be accompanied by very tight stops.’
This week, the Dividend Growth and High
Yield Portfolios Sold Half of their ConocoPhillips positions.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 7/31/13 11475 1422
Close this week 15550 1692
Over Valuation vs. 7/31 Close
5% overvalued 12048 1493
10%
overvalued 12622 1564
15%
overvalued 13196 1635
20%
overvalued 13770 1706
25%
overvalued 14343 1777
30%
overvalued 14917 1848
35%
overvalued 15491 1919
40%
overvalued 16065 1991
Under Valuation vs.7/31 Close
5%
undervalued 10901 1350
10%undervalued 10327 1279
15%undervalued 9753 1208
* 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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