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 14449-19449
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 Uptrend 1600-1756
Intermediate
Term Uptrend 1535-2123
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 46%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. This week’s
economic data reversed the very positive
flow last week and came in weighed to the negative: positives---weekly retail
sales, the July Market flash PMI , June new
home sales, the Kansas City Fed manufacturing index and the index of consumer
sentiment; negatives---weekly mortgage and purchase applications, the May
Chicago National Activity Index, June existing home sales, the July Richmond
Fed manufacturing index, June durable goods, ex transportation; neutral---weekly
jobless claims.
While this
week’s numbers were a bit disappointing, they follow several weeks of upbeat
data. So I am not that concerned about
one week’s worth of stats. The key as
always is whether this week is an outlier or marks the beginning of a trend,
which by definition we won’t know for sometime.
I continue to
leave the yellow light flashing because of the confusion generated over
‘tapering’ which may be manifesting itself in this week’s spurt in interest
rates. Longer term if this move up in
rates continues, I suspect that it will have an impact on investment and
spending plan. However, at the moment,
it is confusion and not higher interest rates that prompts me to keep the
caution flag 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.
The
pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a vulnerable global banking system.
This week the news came from the US where [a] UBS
paid a $900 million fine for mortgage fraud and [b] the CFTC began an investigation in metals market
manipulation by Goldman Sachs and our ‘fortress’ bank, JP Morgan---the latter
being a perfect example of what the banks are doing with all the money that the
Fed is giving them for free.
Saturday
morning humor (5 minute video):
‘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. Unfortunately,
Obama just couldn’t let a good thing continue.
This week He started a new economic campaign which sounded strangely
like His old economic campaign that didn’t work---heavy on promoting income
equality, light on promoting growth.
So it sounds
like this year’s budget wrangle will be another ideological battle. The good news is that it will probably end
like all the rest---in a stalemate that keeps spending under reasonable
control. ‘Reasonable’ being the
operative word in light of the horrendous Farm Bill passed by the GOP
controlled house. The bad news is that
entitlement and tax reform remain a wet dream.
Why
we have to have entitlement reform (medium):
All that said, the shrinking
budget deficit and the serial delays in the implementation of Obamacare remain
short term bright spots in an otherwise cloudy long term outlook.
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.
The multiple
debates continued this week over whether or not Bernanke really intends to
‘taper’, whether ‘tapering’ is ‘tightening’, whether or not investors have
discounted ‘tapering’ and whether or not investors have diminished faith in the
Fed.
However, as I
noted in Friday’s Morning Call, I think that investors, including me, have been
missing the point. The Market has made
clear over the last month that it doesn’t like higher interest rates---whatever
the cause. The reasons they go up or
down will manifest themselves in time.
The point here is to not get too heavily invested in why interest rates are
going up or down because I will waste a lot more time and effort than I have
already wasted trying to justify some thesis about Fed actions when the Fed
isn’t even clear on what it is doing and why.
The point is, are interest rates are going up or down?
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.
Quotes from the
chairman (medium):
The Markets
have spoken and they said that they don’t like higher interest rates, whatever
the reason. In the fullness of time, they
will likely tell us all we need to know about ‘tapering’ and ‘tightening’.
(4) a blow up in the Middle
East . Little new this week.
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.
(4)
finally, the sovereign and bank debt crisis in Europe . This week witnessed more upbeat economic news
out of Europe . It
is still too early to conclude that the EU economy has turned; but at least
there is something upon which to hang ‘hope’.
If we do assume
for the sake of argument that Europe is improving, what
would that mean to our forecast? It
would [a] increase the probability that our ‘muddle through’ scenario will work
out and [b] it would lessen my concerns about a sovereign/bank default. In other words, it would do nothing to alter
our forecast; although it would temper the tail risk of this factor.
But that is
getting a bit ahead of ourselves. For
the moment, I am encouraged by the European economic news over the last two
week, but it is too soon to get jiggy.
To keep things
in perspective:
The situation in Spain
continues to worsen (medium):
Counterpoint:
Bottom line: the US
economy continues to track with our forecast, this week’s lousy numbers
notwithstanding. Fiscal policy is
creating less of a drag than it was a year ago, though my hopes of additional
improvement have been tempered somewhat by the tone and message of Obama’s new
economics campaign. Entitlement and tax
reform seem as far away as ever.
Monetary policy
is unclear despite the best efforts of Bernanke and his colleagues to clarify
‘tapering’. Confusion abounds on whether
or not ‘tapering’ comes sooner or later, whether ‘tapering’ is ‘tightening’ and
whether the Market has discounted ‘tapering’ assuming it comes. Until that uncertainty is removed, it is
likely that businesses and consumers will remain cautious.
In Europe
there is a light at the end of the tunnel, perhaps. Economic data over the last two weeks have
improved but it is far too soon to know if that light is the end of the tunnel
or an oncoming freight train.
Another piece
from the optimist. Note the number of
‘coulds’ and ‘shoulds’ versus ‘is’s’.
(medium):
This week’s
data:
(1)
housing: June existing home sales were well below
expectations, while new home sales were strong; weekly mortgage and purchase
applications fell,
(2)
consumer: weekly retail sales were positive; weekly
jobless claims rose, in line; the University
of Michigan
(3)
industry: June durable goods orders were up, but ex the
very volatile transportation sector, they were off more than forecasts; May
Chicago National Activity Index was very disappointing; the June Markit flash PMI
was better than anticipated; the July Richmond Fed manufacturing index was
negative versus positive estimates, while the Kansas City Fed index was above
expectations,
(4)
macroeconomic: none.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15558, S&P 1690) were quite volatile this week. The Dow broke above the upper boundary of its
short term trading range (14190-15550), negated the break, then broke above
that upper boundary for a second time.
If it closes above 15550 Monday, the trading range will be invalidated,
the Dow will be back in sync with the S&P and the Market will re-set to a
short term uptrend.
While the
S&P remained within its short term uptrend (1600-1756) all week, it did
close below the May high (1687) which should have acted as support. Nevertheless, it rebounded the next day,
tried to challenge that level again on Friday but was unsuccessful.
With a strong
bid under the Market, the bulls are still in control. That suggests that the Dow will re-set to an
uptrend Monday night and we will then shift our attention to the upper
boundaries all uptrends: short term (14880-16000, 1600-1756), intermediate term
(14449-19449, 1535-2123) and long term uptrends (4918-17000, 715-1800).
Volume on Friday
was down; breadth was mixed. The VIX
closed near the lower boundary of its short term trading range and well within
its intermediate term downtrend.
GLD had a good
week and, in fact, is building a very short term uptrend. It, however, remains solidly within both a
short term and intermediate term downtrends.
Bottom line: the
challenge of the 15550/1687 level appears to be coming to an end. If the Dow closes above 15550 on Monday, it
will re-set to an uptrend. At that
point, the Market’s short term trend will also be re-set to up.
And if that
occurs, there will be no overhead resistance save the upper boundaries of the
three major trends (S&P short term---1756, intermediate term---2123, long
term ---1800).
If 1756/1800 (short
and long term upper boundaries) represent the technical upside in stocks, that
is only about up 3-6% from current levels 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
A
technical review of the Market (medium):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15558)
finished this week about 35.6% above Fair Value (11475) while the S&P (1690)
closed 18.8% 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 and, therefore, remains a
positive input to our Valuation Model.
While fiscal
policy is improving by default (sequestration and the tax hike), I was
disappointed by the rhetoric and tone of Obama’s introduction of His new
economic plan this week. Unfortunately,
His focus is still on income inequality (i.e. redistribution) and not on growth. The good news is that nothing will likely
come of it; the bad news is that nothing will likely come of entitlement and
tax reform. Hence, fiscal policy will
remain a headwind to growth in the economy and, more important, to corporate
profits and valuations.
To be sure, the
performance of American business had been nothing short of spectacular in the
last four years. But I believe that businesses have squeezed their
operations about as tightly as they are able and earnings growth via
productivity gains are near an end. For
profit growth to return to historic levels, I believe that less regulation, a
more rational tax structure and less government usurpation of capital are
necessary; and that remains a hope and a prayer.
Monetary policy
is not only lousy but it is, at the moment, confusing. It has done little to improve the economy
while simultaneously injecting risk in the form of bloated bank reserves,
encouraging speculation via promoting the ‘carry trade’, buying up virtually
100% of the US government’s net new financing and being far too confident that
it can manage the transition from easy to tight money---something for which it
has absolutely no historical basis. I
cannot tell you how this story is going to end; but I don’t believe that it
will end well; and because we are in uncharted waters, trying to judge the
impact on our Economic and Valuation Models would be nothing but a wild assed
guess.
Finally, bad
news out of Europe has subsided, at least for the
moment. Because southern Europe
is such a mess, it will take an extended period of improving economic results
to remove the EU from the critical list.
Let’s hope for is a continuation of this nascent trend---which if it
occurs will simply fortify 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 High Yield Portfolio
Sold its position in Sanofi.
Three signs of a Market top (medium):
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 7/31/13 11475 1422
Close this week 15558 1690
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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