9/28/13
I got a call from a close friend offering a trip to South Bend to watch
the Sooners play Notre Dame. So this
note is going early. See you Monday.
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 14926-19926
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 1669-1823
Intermediate
Term Uptrend 1586-2172
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. The
economic data was biased to the upside this week: positives---weekly mortgage and
purchase applications, August new home sales, weekly jobless claims, the August
Chicago national activity index, the September Richmond Fed manufacturing index,
August personal income and spending; negatives---September consumer confidence and
consumer sentiment and the September Markit PMI
manufacturing index; neutral---the Case Shiller home price index, weekly retail
sales, the August and revised July durable goods orders and second quarter GDP
and corporate profits.
So the numbers
remain encouraging. However, investor
attention was elsewhere this week---primarily on the Washington
three ring circus surrounding the continuing budget resolution, debt ceiling, sequestration,
Obamacare and the Fed’s indecision on whether to taper or not to taper. If I was going to write a script to make our
forecast spot on, I don’t think that I could have done any better. As you know, I believe that the fiscal issues
will be decided by a lot of sound and fury; and in the end, it will be business
as usual, i.e. more spending and more taxes.
Monetary policy also is being handled as I expected: ineptly. The caveat being that the Fed is in uncharted
waters and we have no idea what the unintended consequences will be to
QEInfinity. So our outlook remains the
same:
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. If anyone doubted the validity of this
concern, it should have been eliminated after this week’s headlines: JP Morgan
and 12 other banks are being sued over Libor price fixing; JP Morgan will
likely pay in excess of $10 billion to make its mortgage transgressions go away
[but no one is going to jail]; Citigroup gets off light with a $395 million
fine and the EU reported that its banks need $95 billion to meet Basel III
requirements. For those of you who want
to read the gory detail, I have linked to a number of articles:
EU banks need
$95 billion in new capital to comply with Basel III
agreement (medium):
Stunning Libor
fraud admissions (medium):
‘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. With
three days to go until the first deadline, our ruling class is no closer to
solutions to any of the issues [the continuing budget resolution {9/30}, the US
government hitting its debt ceiling {circa 10/15}, the kick in of 2014
sequestration {9/30} and the implementation of a number of provisions of
Obamacare {9/30}]than they were nine months ago---which by the way, is not
surprising. That’s the modus operandi
for these yahoos.
On the other
hand, the political rancor in recent years has been especially high; so we can’t
rule out the possibility that the pols will do something really stupid
especially when the argument involves more than just budget numbers. This time around, Obamacare is in the mix and
that could be the wild card.
That said, in
the end, I think that most of the elected folks’ have an acute sense of
survival; and they know that the electorate is in no mood at present for an
extended government shutdown or a default.
So I expect a lot of huffing and puffing followed by business as usual,
meaning some half assed compromise that includes more unnecessary spending, a
burdensome and ineffective tax code and
too much government intrusion into our lives and businesses.
I
include in each Closing Bell a lament regarding the potential impact that
higher interest rates [the ten year Treasury pushed through 3% two weeks
ago. It has since retreated but not back
to the level from which it spiked---suggesting to me that another move up could
take it to the 3.5%+ level] will 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.
With the
Ber-nank having weaseled on ‘tapering’ and the rising prospect of super dove
Janet Yellen assuming the mantle of Fed chief, I would add another point to the
above and that is, the longer money for nothing goes on, the worse the outcome
I fear. I know all the arguments that the massive build up in reserves has not
resulted in a growth in M2 and therefore a higher risk of inflation. In fact, I
acknowledge that they are correct.
However, the Fed apologists skim over the point that all those reserves
have to be removed in a way not to cause inflation---and the Fed has never done
that before.
They also fail
to mention that when the $3 trillion in government bonds are sold or allowed to
mature, someone has to either buy the bonds that are sold or the new bonds that
replace the cash in the Treasury that paid off the maturing bonds. That is a
lot of new buyers and a lot of money; with that much new supply what happens to
interest rates?
They also fail
to mention the misallocation of capital, the hardship to savers, the
encouragement to speculators that result from artificially low interests and the distortions those cause to our
economy, i.e. slow growth and high unemployment. In sum, QEInfinity [except for QEI] has done
nothing to improve the economy but has created huge inequities and the
inefficient employment of capital that will have to be corrected at some time. The questions are when? and from what level?
Does this seem like a rational strategy
to you (short):
(4)
a blow up in the Middle East. While the carnage in Syria
continues, it is progressing without the active involvement of the US. That lessens the odds of a wider conflict but
at the price of our standing in the world having been diminished
considerably. Good job Mr. O.
So the negative
from an unstable Middle East has now shifted from the
risk of becoming embroiled in a conflict in a country in which the US
has no strategic interest to situation in which our adversaries test our newly
earned status as a weak, bumbling, over the hill power with increasing
frequency and ever more provocative incidents.
(5)
finally, the sovereign and bank debt crisis in Europe. The EU economies continue to improve albeit
sluggishly. This progress likely moderates
somewhat the risk of a crisis as rising tax revenue make sovereign debt service
more manageable which in turn strengthens bank balance sheets [since a huge
percentage of their assets are in their own country’s sovereign debt].
On the negative
side, recent stress tests of bank balance sheets reveal that collectively EU
need another E95 billion in equity to meet Basil III
guidelines.
In addition,
now that the German elections are out of the way, the eurocrats will presumably
resume the task of salvaging the economies, governments and banks of southern Europe. This doesn’t necessarily have to be a
negative. However, it is an unknown
which will likely return to the front pages.
In sum, the EU
economy appears to be emerging from recession.
That should make dealing with the unhealthy fiscal condition of its
southern members a bit easier. I am not
suggesting that all is well; I am suggesting that our ‘muddle through’ forecast
has a better chance of being right.
Bank lending
rates
Bottom line: the US
economy continues to grow but at a sub par rate. The primary causes of this below average
performance are fiscal and monetary policy.
The former is a mess as it always is around budget and debt ceiling
time. Unfortunately, it is unlikely to
change until there is a roll over of our ruling class; and even then, the
change could be for the worse. Monetary
policy appears to be going from bad to really bad, what with the Fed’s back
pedaling on tapering and super dove Janet Yellen in line to become head of the
Fed.
Europe
continues to emerge from a two year 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 all fits
our Model of a sluggishly growing economy restrained by too much spending, too
high taxes, too much regulation and a completely dysfunctional monetary policy
that has led to the misallocation of capital, the mispricing of assets and the
sacrifice of Main Street
savings in favor of bankster speculation.
At the moment, the biggest risk to our forecast is the unintended
consequences of this irresponsible Fed policy.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications rose;
August new home sales increased, in line; the Case Shiller home price index
advanced less than anticipated,
(2)
consumer: weekly retail sales were mixed; both the September
consumer confidence and consumer sentiment indices were slightly below
estimates; weekly jobless claims fell; August personal income and spending were
up and in line,
(3)
industry: August durable goods orders were stronger
than expected, but the July number was revised down substantially; the August
Chicago national activity index rose significantly over the July reading; the
September Richmond Fed’s manufacturing index was well ahead of forecasts; the
September Markit PMI manufacturing index came
in below expectations,
(4)
macroeconomic: the revised second quarter GDP
was up but a bit less than forecast as were corporate profits.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15258, S&P 1691) continues to drift lower following that one day no
tapering price spike. The Dow ended in a short term trading range (14190-15550)
and below its 50 day moving average. The
S&P closed within its short term uptrend (1669-1823) and slightly above its
50 day moving average. Short term, the
indices are out of sync, leaving the Market directionless.
Both of the
Averages are well within their intermediate term (14926-19926, 1586-2172) and
long term uptrends (4918-17000, 715-1800).
Volume on Friday
rose; breadth was negative. The VIX was
up fractionally; 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.
The long bond
was up on Friday and closed within a short term trading range and an intermediate
term downtrend.
GLD moved higher
but remains within a very short term, short term and intermediate term
downtrend. Nothing to do here.
Bottom line: the Averages out of sync on a short term
basis. There are questions being raised
in the technical community about whether or not the one day no tapering spike
was a bull trap. I am not suggesting
that it is; but the thesis has a big enough following to bear mentioning.
I continue to
believe that this is a time to do nothing unless you are skilled trader. The exception being if one of our stocks
trades into its Sell Half
Range, our Portfolios will act
accordingly.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15258)
finished this week about 32.3% above Fair Value (11525) while the S&P (1691)
closed 19.0% overvalued (1429). 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.
Most of the
assumptions in the above forecast are tracking our expectations. The economy
continues to grow sluggishly; but grow nonetheless. Our elected representatives are once again
staging a DC budget melodrama which will likely end with some sort of
compromise that keeps the government funded but does so at your and my expense.
Being
unconstrained by the electorate, the Fed merrily pursues QEInfinity in spite of
a enormous body of evidence that it has been ineffective in attaining the
stated goals of the Fed but at the same time causing unhealthy consequences
distorting capital investment. When this
travesty ends, I fear the aftermath will be worse than anything I have factored
into our Model.
Bottom line: the
assumptions in our Economic and Valuation Models haven’t changed. Economic events appear to be tracking much as
we expected with the exception of monetary policy which has become the biggest
risk to our forecast. I remain confident
in the Fair Values generated by our Valuation Model---meaning that stocks are
overvalued, so our Portfolios maintain their above average cash position. Any move to higher levels would encourage
more trimming of their equity positions.
This week, our Portfolios did nothing.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 9/30/13 11525 1429
Close this week 15258 1691
Over Valuation vs. 9/30 Close
5% overvalued 12090 1500
10%
overvalued 12677 1571
15%
overvalued 13253 1643
20%
overvalued 13830 1714
25%
overvalued 14406 1786
30%
overvalued 14982 1857
35%
overvalued 15558 1929
Under Valuation vs.9/30 Close
5%
undervalued 10948 1357
10%undervalued 10372 1286
15%undervalued 9796 1214
* 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.
