Monday, December 16, 2013

The Closing Bell

12/14/13

Statistical Summary

   Current Economic Forecast

           
            2013

Real Growth in Gross Domestic Product:                        +1.0-+2.0
                        Inflation (revised):                                                              1.5-2.5
Growth in Corporate Profits:                                   0-7%

            2014 estimates

                        Real Growth in Gross Domestic Product                       +1.5-+2.5
                        Inflation (revised)                                                             1.5-2.5
                        Corporate Profits                                                              5-10%

   Current Market Forecast
           
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Uptrend                               15542-20542
Intermediate Uptrend                              15542-20542
Long Term Trading Range                       5050-17400
                                               
                        2013    Year End Fair Value                                     11590-11610

                        2014    Year End Fair Value                                     11800-12000                                          

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                          1750-1904
                                    Intermediate Term Uptrend                       1655-2236 
                                    Long Term Trading Range                         728-1900
                                                           
                        2013    Year End Fair Value                                      1430-1450

                        2014   Year End Fair Value                                       1470-1490         

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                              43%
            High Yield Portfolio                                        46%
            Aggressive Growth Portfolio                           46%

Economics/Politics
           
The economy is a modest positive for Your Money.   Not much economic data this week but what there was, was neutral to positive: positives---mortgage and purchase applications, November retail sales, November small business optimism index; November business inventories and sales; November PPI; negatives---weekly jobless claims, November inventory/sales; neutral---weekly retail sales. 

The only datapoint that I would highlight is the small business optimism index.  I do so because I have raised concerns that the recent antics of our political class could diminish business and consumer confidence and that would in turn negatively influence consumption and investment decisions.  Following a red hot consumer sentiment number last week, this new reading on small business optimism seems to put that worry to rest.

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.
                       
            Another great article from Lance Roberts (medium and today’s must read):

        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.
   
(2) following the busting of the sequester in the latest budget deal, it is clear that the political class remains on its own self serving, spending agenda.  So I am eliminating this positive.

       The negatives:

(1) a vulnerable global banking system.  The only penalty meted out this week was a fine on our ‘fortress bank’, JP Morgan---tagged for enabling the Madoff fraud.

There was some new information on the fired Goldman bank examiner that provides some entertaining reading:

Finally, the Volcker Rule was approved this week and confirmed yet again my reasons for being cynical about the government/Wall Street axis.  While there were some provisions in this new regulation that would hamper some forms of risk taking by the banks, it did little to curb the most egregious offenses and hence, solve the too big to fail problem.

‘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.  The new budget proposal was released this week.  Assuming that it is passed, the good news is that [a] investors/the electorate won’t have to endure another shutdown threat for two years  and [b] the increased spending could act as a stimulus short term. 

The bad news is the increased spending.  The one discipline in place to restrain our political class’ passion for dispensing goodies to the masses is no more.  To be sure the initial step toward higher government spending is a small one.  However, it is likely only a matter of time before the temptation to increase the size of the government relative to the economy will simply prove uncontrollable---and we will be off to the races again.

All of which ignores the 900 pound gorilla in the government expenditure room---Obamacare.  Gosh only knows what the next budget is going to look like with the as yet to be determined costs of ‘affordable healthcare’ and now no spending constraints. 


(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. 

CNBC made a prediction this week that tapering would begin in December---next week in fact.  I don’t agree; but with the budget deal eliminating any disruptive fiscal issues from the economic landscape, investors reacted by driving the Markets lower initially.    

You know my position: there are two possible ending scenarios in this tragedy: [a] the Fed remains paralyzed by the difficulty of their position and the Markets eventually take matters into their own hands, spiking upward the entire yield curve and forcing the Fed into a transition to tighter money by raising rates at the short end, [b] in desperation to be showing that it is doing something, the Fed acts and bungles the transition on its own.  Clearly if tapering starts next week, this becomes the operative scenario.

That said, my conclusion hasn’t changed: [a] the Fed has pushed monetary into uncharted territory, [b] nobody has a clue as to the economic or Market consequences of unwinding that policy, [c] the longer it goes on, the worse those consequences will be, [d] as bad as all that could be, if history repeats itself, the Fed will make a mess of whatever strategy it follows in the transition process.


              How paper money regimes end (medium and today’s must read):

(4)    a blow up in the Middle East.  The administration is busy trying to sell an Iran deal to congress, although there doesn’t seem to be an international consensus on exactly what that is.  My concern as you know is that Obama will give away the ranch in order to generate a bit of what He at least thinks is good news.  If that occurs, it will likely put Israel and most of the sunni muslim powers on red alert and could likely be more de-stabilizing than no agreement.

Iran walks out of negotiations (medium):

Meanwhile, things aren’t going all that swimmingly in Syria (medium):

(5)   finally, the sovereign and bank debt crisis in Europe.  The economic news out of Europe remained mixed this week.  My hope is that Europe is recovering in the same fashion as the US---slowly, fitfully but on a sustained basis.  That would allow our ‘muddle through’ scenario to remain in tact. 

Bottom line:  this week’s stats really didn’t tell us much about the economy. We did receive an upbeat small business optimism index reading which combined with last week’s consumer confidence reading appears to put to rest my concern about declining business and consumer sentiment negatively impacting growth.

The CNBC story of tapering I think will prove incorrect; but if it is true, get you crash helmet on.

The political news dominated the headlines this week and were hardly positive.  Our ruling class crafted a new budget that does away with the mandatory sequester cuts, so we lost the only fiscal policy positive in outlook.  In addition, the new Volcker Rule was approved; and despite its 900 page length, it did very little to deal with our ‘too big to fail’ bank problem.  

There was little out of Europe this week to alter our outlook which remains that it will ‘muddle through’.

This week’s data:

(1)                                  housing: weekly mortgage and purchase applications were up fractionally,

(2)                                  consumer:  weekly retail sales were mixed, while November retail sales were better than forecast; weekly jobless claims soared,

(3)                                  industry: the November small business optimism index was slightly better than anticipated; November wholesale sales trailed the rise in wholesale inventories while business inventories and sales advanced,

(4)                                  macroeconomic: the November budget deficit was considerably less than expected; November PPI fell, in line with estimates.

The Market-Disciplined Investing
           
  Technical

The indices (DJIA 15755, S&P 1775) had another down week, but remained within uptrends along all timeframes: short term (15542-20542, 1750-1904), intermediate term (15542-20542, 1655-2236) and long term (5050-17400, 728-1900).

Volume on Friday fell; breadth improved, though stocks remain oversold. The VIX was up fractionally, closing within its short term trading range and intermediate term downtrend.   It continues to provide no guidance on Market direction. 

The long Treasury was up, finishing well within a short term trading range and an intermediate term downtrend and continuing to build a head and shoulders formation.

GLD was also up but its pin action remains terrible.  It closed within its short and intermediate term downtrends and lingers near the lower boundary of its long term trading range---a breach of which would be very bad news for GLD holders.  If there is any good news in this sorry tale, it is that it is holding above that lower boundary.

Bottom line:  all trends of both indices are up.  This week witnessed another shot by the bears to take this Market down.  Someday they will be successful; but until that happens, you have to assume the uptrend will continue.

Nevertheless, I continue to believe that the most likely upside targets are the upper boundaries of the Averages long term uptrends (17400/1900).  If that is the case and the downside is simply Fair Value (11600/1440), then the risk reward from current levels is not all the attractive.

If one of our stocks trades into its Sell Half Range, our Portfolios will act accordingly.

               
   Fundamental-A Dividend Growth Investment Strategy

The DJIA (15755) finished this week about 35.8% above Fair Value (11600) while the S&P (1755) closed 21.8% overvalued (1440).  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 track our forecast; the stand out number for me being the positive small business optimism index. 

However, our political class tossed a curve ball (I don’t why I am surprised).  It appears the sequester mandates are dead---so it is back to business as usual, i.e. ‘some sort of half assed attempt at getting fiscal policy under control’.  And as a bonus, the regulators constructed a Volcker Rule that Bernie Madoff could live with.

Economic news out of Europe continues to be mixed but there is nothing to indicate that our ‘muddle through’ scenario isn’t operative.

The wild card in our economic/Market future is QEInfinity.  The debate continues within the Fed and among market participants on when to taper, by how much and what the likely consequences will be.

Early in the week, CNBC posited that the Fed would announce a start to tapering at next week’s FOMC meeting.  As you know, I doubt that it will happen; though if it does, it would be a long term positive.  To qualify that a bit, the sooner the Fed begins shrinking its balance sheet, the less potential Market pain we will likely have to endure---but there still will likely be lots of pain. 

And to qualify that even further no one has a clue as to how the process of unwinding QE will end because we have never been here before.  In the past, when the Fed began shrinking bank reserves, it resulted in higher long term interest rates (lower bond prices) which spilled over into the stock market..  My assumption is that this will occur again, only this time with more vengeance.

The other caveat is that the Fed may either lose control of the process or, even worse, never have it in the first place.  Market forces have often overpowered Fed policy in the past; and given the current extremes the Fed has gone to, investor fear or some exogenous circumstance could wrest interest rate management from its hands.

So while I can’t say with certainty that the transition to tighter monetary policy will be an ugly one, I can say no one knows what it will look like.  And that should give anyone pause with valuations are present levels.

Bottom line: the assumptions in our Economic Model haven’t changed; and the budget deal and the new Volcker Rule assures us that things aren’t likely to get dramatically better.  The one thing that could change our assumptions is if the Fed starts or is forced by the Market to start to taper and some as yet unforeseen consequence occurs. 

The assumptions in our Valuation Model have not changed either.  I remain confident in the Fair Values calculated---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.

That said, I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.

           The latest from Lance Roberts (medium):

          This week our Portfolios did nothing.
       
DJIA                                                    S&P

Current 2013 Year End Fair Value*                11600                                            1440
Fair Value as of 12/31/13                                 11600                                                  1440
Close this week                                                15755                                                  1775

Over Valuation vs. 12/31 Close
              5% overvalued                                 12180                                                    1512
            10% overvalued                                 12760                                                   1606 
            15% overvalued                             13340                                             1656
            20% overvalued                                 13920                                                    1728   
            25% overvalued                                   14500                                                  1800   
            30% overvalued                                   15080                                                  1872
            35% overvalued                                   15660                                                  1944
            40% overvalued                                   16240                                                  2016
           
Under Valuation vs.12/31 Close
            5% undervalued                             11020                                                      1368
10%undervalued                                  10440                                                  1296   
15%undervalued                             9860                                                    1224

* 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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