The Closing Bell
Next week starts a lot of absentee time for me. Number one grandson arrives today and we will
visit several colleges in the area. The
following week, number two granddaughter and number three grandson arrive and
we go to the beach. A week later is
Labor Day and we are taking an extended holiday. The following two weekends, we have a
housewarming in Savannah
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 14498-19498
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 1606-1762
Intermediate
Term Uptrend 1538-2126
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 was basically mixed:
positives---the Case Shiller home price index, the ADP
private payroll report, weekly jobless claims, the July Markit PMI ,
the July ISM manufacturing index, June personal spending; negatives---weekly mortgage
and purchase applications, consumer confidence, the July Chicago PMI ,
Dallas Fed manufacturing index, July nonfarm payrolls, and June personal income;
neutral---June pending home sales, weekly retail sales, second quarter and
revised first quarter GDP and June/revised
May factory orders.
There were some
highlights within both the positive (ISM manufacturing index) and negative
(July nonfarm payrolls) numbers; but all in all the data flow confirms our
outlook. Also in this mix was the
statement from the latest FOMC meeting which (1) pointed to a slightly weaker
economy and (2) completely ignored the ‘tapering’ issue.
Whether the
latter was an unconscious decision or reflected the fear that if anything was
said, it would introduce more volatility into the Markets, I would argue that
it demonstrates the Fed’s continuing confusion over what to do with
QEInfinity. While that may not directly
impact the data tomorrow, it does create enough uncertainty to leave businesses
and consumers hesitant to invest and spend---and that keeps a lid on economic
growth.
If Bernanke
wanted to be clear about Fed policy, he would have reiterated his policy
statement made during his recent congressional testimony. Indeed, given the Market’s sensitivity to
this issue, Bernanke should repeat that policy statement every morning as he
eats his Post Toasties.
For that reason,
I am leaving the yellow light flashing on our forecast which otherwise looks to
be right on track:
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 included more problems of cheating from JP Morgan and
unexpectedly large deleveraging of the Deutsche bank balance sheet.
JP Morgan fines
over the last two years (medium):
One more
example of the banksters defrauding investors (medium)
And for the
true cynics (medium);
http://www.nakedcapitalism.com/2013/08/trader-describes-how-dishonesty-pays-in-finance-big-time.html
Deutsche Bank
deleveraging at record pace (medium):
Bad loan
problems at Italian banks (medium):
Of course, less
than stellar behavior from our ‘fortress’ bank has gotten to be old news. However, Deutsche Bank massive unwinding of
its derivatives portfolio may be saying a great deal about the risk being
carried on EU/US bank balance sheets in general---which as you know, is one of
the primary worries I have with respect to the health of the global financial
system.
‘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. Obama
continued His new economic campaign, this week offering up His version of a
‘grand bargain’ which [a] said nothing about entitlement reform and [b] instead
of lowering the tax rate and extending the base for all taxpayers, it {1}
ignored individuals completely, {ii} also left out small business---which as
you know, generate most of the job growth, {iii} eliminated the tax breaks on
corporate overseas earnings and {iv} hiked spending on social
programs---programs on which, I remind you, that the government has already
spent hundreds of billions with little or no impact on growth in the economy or
jobs.
This just adds
one more irreconcilable issue to full plate of economic problems [budget, debt
limit, Obamacare] that must be dealt with in the fall. 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.
The
Detroit template:
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 debates
continued this week about 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. It was not helped by the absence of
any reference to ‘tapering’ in the press release from the latest FIMC
meeting. It seems to me that if Bernanke
meant what he said during his latest congressional testimony and he wanted to
be sure that Markets remained calm, there would have been a reiteration of that
stance in the Fed statement. No such
luck.
Given what I
see as continuing confusion regarding the aforementioned issues, I have been
simply focusing on interest rates as an indication of the net consensus among
bond investors on Fed policy. It is too
soon to tell if that is a workable strategy; but it is one that I am testing at
the moment.
Bottom line: my
thesis has been that Fed will repeat its past mistakes and botch the transition
from easy to tight money. The lack of
any mention of ‘tapering’ in the statement following this week’s FOMC meeting
reinforces that notion. My concern is
that the longer the Fed continues on its current QEInfinity path, the more
painful the transition process will be.
The Fed’s dual
mandate (medium):
The Fed and
trust (medium)
(4) a blow up in the Middle
East . The big news this
week was the closing of US embassies across the Middle East
over concerns about a terrorist attack.
Ignoring for the moment the endless policy mistakes that have occurred
because ‘al Qaeda has been decimated’, this, nonetheless, reminds us that we
are at war, our enemy inhabits the Middle East and that means the potential for
disruptions in the supply or transportation of oil 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 though the picture of the banking system
remains quite weak.
As I noted last
week: ‘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 three
weeks, but it is too soon to get jiggy.
The state of
the Greek banks (short)
And the state of the Greek state
(medium):
And the state of unemployment in Spain
(medium):
http://www.zerohedge.com/news/2013-08-02/spain-suffer-least-25-unemployment-until-2018-imf-forecasts
Bottom line: the US
economic data remains encouraging. Fiscal
policy may be creating less of a drag (sequestration and the tax hike) than it
was a year ago, but the tone out of Obama and congress suggests that
entitlement and tax reform are little more than a wet dream. Furthermore, on a short term basis, September
maybe a tough month on this front with 2014 appropriations bills due, a likely
vote on the debt limit and the kick in of the next round of sequestration.
Monetary policy
is the stick of dynamite stuck up our ass.
Confusion abounds and the lack of any comment in the FOMC press release
simply adds to the problem. In my
opinion, the Fed knows that the magnitude of QEInfinity has put its policy in a
precarious position, but is scared sh**less to let the Market know. Until that uncertainty is removed, it is
likely that businesses and consumers will remain cautious.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications fell
[again]; the Case Shiller home price index continued strong on a year over year
basis; June pending home sales were off less than anticipated,
(2)
consumer: weekly retail sales were mixed; the ADP
private payroll survey was better than forecasts as were weekly jobless claims;
but July nonfarm payroll increased less than expected; June personal income was
less than estimates while spending was more; the index of consumer confidence
was slightly below anticipated results,
(3)
industry: the July ISM manufacturing index was better
than forecast; the July Chicago PMI was
below expectations as was June construction spending; June factory orders were
up less than estimated, though May’s number was revised upward; the July Markit
PMI was a tad better than anticipated; the
July Dallas Fed manufacturing index was below expectations,
(4)
macroeconomic: second quarter GDP
was much better than forecasts; but first quarter GDP
was revised down; the release from the latest FOMC meeting turned a bit more
dovish and failed to mention ‘tapering’.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15628, S&P 1706) were quite volatile this week. The Dow round tripped the upper boundary of
its short term trading range (14190-15550) again, but finished the week above
that level. A close Monday over 15550
will re-set the DJIA’s short term trend to up (14994-16000).
The S&P
remained within its short term uptrend (1606-1762) all week, but did trade
below the May high (1687) twice.
Nevertheless, it ended the week on a very strong note.
Both of the
Averages are well within their intermediate term (14498-19498, 1538-2126) and
long term uptrends (4918-17000, 715-1800).
Volume on Friday
was flat; breadth was negative. The VIX
closed right on the lower boundary of its short term trading range and well
within its intermediate term downtrend.
A break below the trading range lower boundary would be positive for
stocks.
GLD reversed the
prior week’s strong performance, breaking its very short term uptrend. That leaves it within its short and
intermediate term downtrends. Nothing to
do here.
Bottom line: the
challenge of the 15550/1687 level appears to be coming to an end. Of course, that was my conclusion last week;
so not that much has changed. On the
other hand, the move to the upside this week was much more pronounced than the
week before. So it seems more likely
that it will, in fact, happen this time around.
If the Dow does close 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---1762, intermediate term---2126, long
term ---1800).
If 1762/1800 (short
and long term upper boundaries) represent the technical upside in stocks, that
is only about up 3-5% 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
How
are the Markets in the rest of the world doing? (short):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15658)
finished this week about 36.1% above Fair Value (11500) while the S&P (1709)
closed 19.8% 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 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 again disappointed
by the rhetoric and tone of Obama’s introduction of His ‘grand bargain’. Like His new economic plan which was simply
more of the same old income distribution routine, His ‘grand bargain’ was
neither grand nor a bargain. Meanwhile,
the GOP was not about to be left out of this budget clusterf**k---Boehner
announced that the republican controlled house would not have an appropriations
bill by its due date (9/30).
In other words,
ideology and institutional sclerosis continue to rule fiscal policy. While there is no doubt that the economy is
benefiting from weaker headwinds, there is still too much spending, too high
taxes and too much regulation to prompt the kind of confidence and behavior in
businesses and consumers that would lead to a return to historical levels of
growth.
So while
businesses will continue to do what they to best, i.e. figure out how to raise
revenues and earnings despite inept fiscal leadership, it appears that they
will have to spend more time than needed dealing with fiscal restraints and
less time than necessary to close the current gap between production and
capacity and move economic growth to a higher level. Hence, fiscal policy will remain a headwind
to growth in the economy and, more important, to corporate profits and
valuations.
Monetary policy continues
to push into uncharted territory.
Despite the Fed’s inability to stimulate economic activity, it persists
in pumping money into bank reserves which serve only to (1) allow the
government to finance its irresponsible fiscal policy and (2) encourage
speculation within the banking class via promoting the ‘carry trade’ which is
driving asset prices into ‘bubble’ territory.
Despite the
Fed’s pontificating about its policies for unwinding the massive expansion of
its balance sheet and how they are ‘data driven’, history says that it doesn’t
have a f**king clue. Remember, it was
only a few years ago that Bernanke said that there were no problems in the
housing industry. All the on again, off
again nonsense on ‘tapering’ is an even more recent example of the limited
understanding that the Fed has of its power to forecast and control outcomes.
I end with what
has become my weekly refrain: I cannot tell you how this story is going to end;
but I don’t believe that it will end well.
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, the
economic news out of Europe improved again this
week. This is starting to look like a
trend; and if that turns out to be the case, then the Markets will have dodged
a major bullet. Of course, it is not over
yet. The financial system is
overleveraged with too much junk debt.
Plus only God knows the extent of the banks’ exposure in the derivatives
markets. For the moment, let’s hope for
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, are 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, 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 15658 1709
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.
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