8/24/13
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 14643-19643
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 1628-1783
Intermediate
Term Uptrend 1554-2142
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. It was
a very slow week for economic data; and what we got was modestly upbeat:
positives---weekly purchase applications, July existing home sales, the Markit
flash PMI, July leading economic indicators
and the Kansas City Fed’s August manufacturing index; negatives---weekly mortgage
applications, July new home sales, weekly jobless claims; neutral---weekly
retail sales, the Chicago Fed’s July national activity index.
The big news, of
course, was the release of the minutes from the latest FOMC meeting. They showed a Fed that was slightly more
pessimistic on the economy and a bit more ambivalent on ‘tapering’.
I am not
particularly concerned about this less optimistic view of the economy. The fact is that the general flow stats from
the US economy
continues to track our forecast. Plus
there has been a steady stream of upbeat numbers out of Europe---which
one would think would be helpful to the US
economy’s advance.
The issue of
‘tapering’ remains fraught with confusion; probably because the Fed seems just
as confused as everyone else about what to do, when to do it and what the
impact of ‘tapering’ will be. As I noted
in Thursday ‘s Morning Call, because QEInfinity has had so little positive influence
on the economy, I am not at all convinced that ending it will have any negative
effect. (more on that later). However,
given the probable proximity of the transition from easy to tight money, until
we know for sure the impact ‘tapering’ will have on the economy, I am leaving
the yellow light flashing. Our forecast
remains:
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 is awash in cheap, clean burning natural
gas.... In addition to making home heating more affordable, low cost, abundant
energy serves to draw those manufacturers back to the US who are facing rising foreign
labor costs and relying on energy resources that carry negative political
risks.
The
negatives:
(1) a
vulnerable global banking system. This
week the news included the relentless pursuit of JP Morgan’s misdeeds by
multiple Federal regulatory agencies, Moody’s putting Goldman, JPM,
Morgan Stanley and Wells Fargo on review for downgrade and the increase in bad
loans in Spanish banks.
‘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. Obamacare
held much of the spotlight this week as company after company along with
nonprofit and even governmental agencies alter [read ‘lower’] their healthcare
benefits because of the negative [read ‘costly] impact of this misbegotten
piece of social engineering. We knew
early on that no one had a clue about what this piece of crap was going to cost
Americans. Now that employers are
pushing the numbers, we know that it is expensive and unworkable. But we don’t know how much of an additional
burden it will ultimately prove to be on overall economic activity.
Meanwhile, the
debates over the budget [the fiscal year ends 9/30] and the debt ceiling loom
in September. I have no clue how those
issues will be resolved; although on Friday Boehner assured the electorate that
there would be no government shutdown.
Which begs the question; does that also mean that he assured the
electorate that there would be higher spending?
Whatever happens, September will likely be a fun filled month of
political acrimony.
I
include in each Closing Bell a lament regarding the potential impact that
higher interest rates will have on have on the budget deficit. Now those risks are upon us: As I
have noted previously, the US government’s debt has grown to such a size
that its interest cost is now a major budget line item---and that is with rates
at/near historic lows. Moreover, government
debt continues to increase and the lion’s share of this new debt is being
bought by the Fed.
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 debates
continued this week about whether or not the Fed really intends to ‘taper’ and
if so when; though I think that consensus is moving in the direction ‘yes’ and
sooner rather than later---helped along, as it often is, by the price action in
the fixed income market. I have pursued
this subject ad nauseum this week so I don’t want to be repetitious; but let me
summarize:
[a] the
transition from easy to tight money has to start some time and it appears to be
drawing nigh,
[b] the Fed has
a dismal record of success in prior transitions,
[c] unfortunately,
this time around the Fed must start the transition from and unprecedented
absurd level of monetary ease,
[d] the good
news is that QEInfinity did little to improve the economy, so it is reasonable
to assume that it will do little to hurt when the economy as it comes to an end. The problem with ‘tapering’ is not if, when
and by how much it will occur. The
problem is the uncertainty created by the Fed’s seeming confusion about it
makes businesses and consumers less inclined to invest and spend. If the Fed will just tell us already what it
intends to do, we all can make our plans accordingly.
[e] the bad
news is that QEInfinity has created bubbles in multiple asset classes largely
through the so called ‘carry trade’ in which the trading desks of banks and
hedge funds borrow cheap money provided by the Fed and speculate in other
potentially higher return securities,
[f] bond
investors appear to have had enough and are starting to drive rates up all
along the yield curve, save for the very short term rates which the Fed
controls,
[g] this has
tightened sphincter muscles of all investors.
Whether this is the start of a great ‘unwind’ in all those asset bubble
trades remains to be seen; but the risk certainly seems to be growing.
[h] the Fed can
always come out tomorrow and promise QE to Infinity. But until is does and investors believe it,
this situation remains dicey at best and could really get ugly at worse.
QE is betrayal (medium):
Here is an
interesting take: bonds rates are up because the bond guys believe that the Fed
won’t ‘taper’; of course in the end, it doesn’t matter, higher rates are still
crushing the ‘carry trade’:
(4)
a blow up in the Middle East. The turmoil heightened this week in [a] Egypt
where both the new military government and supporters of the Muslim Brotherhood
escalated the killing and [b] Syria
where supporters of the opposition were gassed---by whom is uncertain.
How
about that Arab Spring, sports fans?
As usual, the US
is on the wrong side of these conflicts to the extent that we are even
involved---which in no way means that the rest of world, especially the major
oil suppliers in that region, aren’t choosing up sides and placing their bets.
My sympathies
here are with Henry Kissinger: it is a shame that they both can’t lose. That said, there is a lot at stake in both
countries in terms of oil transportation [Egypt---the
Suez Canal; Syria---a
natural gas pipeline supplying Europe]. Leaving aside our inept foreign policy, the
world is still dependent on Middle East oil and an increasing number of players
are becoming more deeply involved every day---which means probability of a
misstep by any one party grows and with it the potential for disruptions in the
supply or transportation of oil.
(5)
finally, the sovereign and bank debt crisis in Europe. We have seen enough upbeat economic news out
of the EU over the past month to assume that the odds have increased that Europe
is finally lifting out of recession.
That is clearly good news for the US
economy in the sense that a rise in EU demand
should help overall US
economic growth as well as the earnings from companies with a large European
exposure.
In addition on
the margin, this improvement will undoubtedly lessen the risk of a sovereign or
bank default. Rising economic activity
should produce higher tax revenues for the governments and profits for the
banks, thereby lowering the chances of a default. However, offsetting that is the increase in
interest rates which will require more funds to service the sovereign
debt. Furthermore, remember that the
European banks are massively overleveraged---a condition that won’t be remedied
easily.
In short, the
EU’s economic improvement is a positive and lessens the probability of a
sovereign or bank debt crisis. So,
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.’
Bottom line: the US
economic data remains encouraging. Fiscal
policy which has been mildly positive of late (sequestration and the tax hike) is
about to move into the limelight as negotiations on the budget and the debt
ceiling commence in September, a second round of sequestration kicks in with
all the likely attendant doomsday forecasts and the wrangling over Obamacare
exposes more costly flaws. In short, the
economy will likely get no help from fiscal policy.
Monetary policy
is everyone’s focus at the moment primarily due to concerns about the potential
impact of rising interests rates on economic activity. While I have some sympathy with that notion,
as I have said previously, easy money did very little for the economy even the
interest sensitive sectors (housing); so I am more inclined to think that its
absence will likely do little harm. The
more important aspect for the economy is the uncertainty about if, when and how
much ‘tapering’ will occur. It is that
uncertainty that tends to keep businesses and consumers from investing and
spending.
Europe
seems to be coming out of its recession.
That is a positive in the sense that it increases the probability of our
‘muddling through’ scenario. However, it
remains a long road to unwind the enormous leverage of both sovereigns and
banks.
This week’s
data:
(1)
housing: weekly mortgage applications fell [again],
though purchase applications were slightly up; July existing home sales were
much better than anticipated while new home sales were very disappointing,
(2)
consumer: weekly retail sales were mixed; weekly
jobless claims rose more than forecast,
(3)
industry: the Chicago Fed’s July national activity
index was weak but not as much as
expected; the August Kansas City Fed’s manufacturing index was ahead of
forecasts; the August Markit flash PMI was
slightly better than estimates,
(4)
macroeconomic: July leading economic indicators were
up, in line; the minutes from the latest FOMC meeting revealed a Fed that [a]
was a bit more pessimistic about the economy and inflation, [b] split over
‘tapering’, [c] but comfortable with the ‘data dependent’ conditionality of
‘tapering’.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15010, S&P 1663) experienced some sharp moves in both directions this week
but ended on a positive note---helped enormously by spike up in Microsoft after
Ballmer announced his retirement and the bad news is good news take on plunging
new home sales. The Dow ended in a short
term trading range (14190-15550), while the S&P remained within its short
term uptrend (1628-1783).
Both of the
Averages are well within their intermediate term (14643-19643, 1554-2142) and
long term uptrends (4918-17000, 715-1800).
This leaves the
indices out of sync (S&P up, Dow flat); plus the DJIA is below its 50 day
moving average while the S&P managed to close above its 50 day moving
average on Friday. In sum, this means
that the Market direction is indecisive.
Volume on Friday
declined; breadth was mixed. The VIX
closed down 5%. But for all intents and
purposes, this indicator has been flat since the first of the year (short term
trading range). Nevertheless, it is also
firmly within its intermediate term downtrend.
GLD was strong
this week and continues to build on a very short term uptrend. However, it is still within its short term
and intermediate term downtrend.
Bottom line: with
the Averages out of sync and divergences occurring in several other technical
indicators, this is the time to do nothing unless you are a very good trader.
Margin
debt at risky levels:
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15010)
finished this week about 30.5% above Fair Value (11500) while the S&P (1663)
closed 16.6% overvalued (1426). 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 grow sluggishly, in line with our forecast. It is amazing how well it has hung in there
considering the entire global political class seems intent on doing everything
in its power to screw things up. It
speaks well of our business class and the tenacity of most Americans.
Speaking of
political classes, ours is apparently having way too much fun engaging in
ideological warfare to bother with such mundane, plebian matters as managing
the ship of state. The good news is that
their forces are so evenly matched that the danger of them imposing even more
burdens on the electorate than they already have is close to nil. The bad news is that they have already done
enough damage to keep the rest of us busy for a long time to come just trying
to cope with it.
So while fiscal
policy may be improving by default (sequestration and the tax hike), the
upcoming negotiations on the budget and debt ceiling will likely not make for
upbeat headlines. With the entire
Washington community now looking to 2016 and with little indication that they
will do anything for the greater good, I am not convinced that much will get
done other than keeping the fiscal affairs on life support long enough to get
to the 2016 elections. That is not a
necessarily bad thing for the economy if spending can be held in check; but it
could cause heartburn for the Market.
Meanwhile, the costs of Obamacare keep rising and that is not good for
anyone.
Monetary policy has
reached the status of an Abbott and Costello routine. No seems to know if ‘tapering’ is going to
occur, when it is going to occur and how large it will be---including
apparently most members of the FOMC.
Small wonder that many investors are confused.
As I have made
clear, in this transition, I think that the risks for the Markets are greater
than those for the economy. They are the
only entities that have truly benefited from QEInfinity; hence, it would seem
that they are ones apt to take it in the snoot when this extraordinary policy
is unwound. I end this part of the
discussion as I always do: I cannot tell you how this story is going to end;
but I don’t believe that it will end well.
Finally, the
economic news out of Europe has improved consistently
enough over the last month that our ‘muddle through’ scenario may actually have
a chance of being correct. To be sure,
major risks still exist in the form of overly indebted sovereigns and over
leveraged banks; but economic growth can cure a lot of ills. In the end, this still represents a
significant risk, just not as significant as it was several months ago.
Bottom line: our Valuation Model hasn’t
changed sufficiently to alter the Fair Values of the stocks in our Portfolios---which
as you know are considerably below current price levels. Hence, there are very few bargains and a
goodly number of stocks that are overvalued.
That suggests a continuation of our
strategy of lightening up on any of our stocks that trade into their Sell
Half Ranges
and deferring purchases of even those stocks on our Buy Lists until the current
excesses in the Markets are being wrung out.
This week, our Portfolios did nothing.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 8/31/13 11500 1426
Close this week 15010 1663
Over Valuation vs. 8/31 Close
5% overvalued 12075 1497
10%
overvalued 12650 1568
15%
overvalued 13225 1639
20%
overvalued 13800 1711
25%
overvalued 14375 1782
30%
overvalued 14950 1853
35%
overvalued 15525 1925
40%
overvalued 16100 1996
Under Valuation vs.8/31 Close
5%
undervalued 10925 1354
10%undervalued 10350 1283
15% undervalued 9775 1212
* 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.
