Thursday, December 19, 2013

The Morning Call--A masterful bit of finesse

The Morning Call

12/19/13

The Market
           
    Technical

            So much for that very short term downtrend---gone.  The indices (DJIA 16167, S&P 1810) rallied mightily, closing near their former highs and within uptrends along all major timeframes: short term (15566-20566, 1756-1910), intermediate term (15566-20566, 1660-2241) and long term (5050-17400, 728-1900).

            Volume rose (modestly); breadth improved though the flow of funds and on balance volume indicators saw little of it.  The VIX dropped 14% but remained well within its short term trading range and intermediate term downtrend.

I ran another check of our internal indicator.  In a universe of 149 stocks, 19 finished the day at the proximate level of their all time highs (in line with the Averages), 21 closed above their former highs while 109 remain noticeably below their recent highs. To say that this is a significant divergence would be an understatement and, at least as of yesterday’s close, doesn’t suggest a strong follow through.

The long Treasury fell slightly, indicating that the bond guys were not nearly as emotional about the day’s events as the stock boys.  It closed within a short term trading range and an intermediate term downtrend and continues to build a head and shoulders formation.

GLD declined, leaving it within short and intermediate term downtrends and nearing the lower boundary of its long term trading range.  As long as it holds this level, all is not lost; but there is little else about which to be happy.

Bottom line:  investors have to be overjoyed with yesterday’s price performance; and I am sure are anticipating even better times to come.   As you know, I have opined that there is a better than even chance of the indices challenging the 17400/1900 level.  Given yesterday’s bombastic pin action, the question is, should I raise those objectives and give myself a little more room?  Not at the moment at least. One day does not a trend make; so follow through remains a key; and our internal indicator actually supports the notion of a limited follow through/upside.  So I am sticking with my targets and will continue to use any advance as an opportunity for our Portfolios to take advantage of our Sell Price Discipline.
      
    Fundamental
    
     Headlines

            Yesterday’s economic news was mixed: weekly mortgage and purchase applications were down while November housing starts were gangbusters.  Overseas, UK unemployment hit a four and a half year low.

            ***overnight, the senate passed the new budget and Chinese interest rates spiked causing the Bank of China to ease liquidity conditions.

            Of course, none of that is relevant because the big news of the day was the Fed’s decision to start tapering---which it did in a masterful way: (1) it was tapering for pussies, i.e. it is only reducing its bond buying by $10 billion per month [so it is still buying $75 billion a month] and (2) it loosened up its guidelines for when any rise in the Fed Funds rate might occur.  So it took away a tiny bit of liquidity with one hand and offered an expended vista of lower interest rates with the other.  My hat is off to the Ber-nank for this finesse move.  Clearly, the stock jockeys agreed, though the rest of the Market [bonds, commodities] seemed relatively unimpressed.

            This makes me wrong on the call that the Fed wouldn’t taper in December if ever; but that is a lesser issue than:

(1)     am I wrong that the Fed will botch the transition? Has the Fed [Bernanke] really figured out how to make the transition from easy to tight money?  To be sure, one day of investor approval is not a sign of long term success; but it does raise the point: will this time be different?  I hate the very concept of ‘this time is different’ especially when there exists so many examples of the Fed’s inability to manage a transition properly.  Still, the issue is now before us and we must pay attention and allow for the possibility.  That is not the same thing as betting money on it at this early date.  But it is being prepared to be open minded and flexible.

(2)     am I wrong that either tapering will prompt a severe reaction from the Markets or that, sooner or later, the Markets will refuse to go along with a molasses like transition process?  Yesterday’s pin action notwithstanding, again, way too soon the make that call.  But let’s assume that I am wrong that the tapering process will be the catalyst that prompts investors to make a more realistic assessment on valuation---that doesn’t mean that some other event or series of events won’t.   As I noted previously, stocks can remain overvalued for a period of time until some event slaps investors ‘up side the head’.

(3)     finally, I should point out that even if [a] the Fed has figured out how to transition to a normalized monetary policy and, hence, avoid the negative economic consequences of either a too rapid or to slow transition to tighter money and [b] investors retain complete faith in Fed policy, they are only tangentially related to current overvaluation in stocks.  Stocks are overvalued based on historical relationships between price and trailing earnings, price and sales, price and book value and all the other valuation measures that I reference time and again on these pages.  The fact that the Fed won’t screw the pooch and make those valuation measures appear even worse, doesn’t keep them from being out of line today anyway.

Bottom line: clearly, I was wrong that the Fed wouldn’t start tapering, though I give myself some style points based on the lack of muscle in the taper and the fact that Bernanke suggested interest rates could stay low for my lifetime.  Nonetheless, a start has been made.  The questions are; (1) will it prove effective in unwinding QE without causing economic disruptions? [way too soon to know], (2) will it even matter to the Markets if current overvaluations persist or get more extreme? [this won’t continue indefinitely].

 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.

            Goldman’s take on the Fed action (medium):

            Hilsenrath’s take (medium):

            The key points and projections from the FOMC statement (short):

            Tapering versus tightening (medium):
                       
            Is this move a ‘feeler’? (short):

            What we learned (medium):

                What happened the last time a major central bank tapered (medium):

       Investing for Survival

6 retirement myths you should ignore (medium):

            The latest from Doug Kass (medium):




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. Steve's goal at Investing For Survival is to help other investors build wealth and benefit from the investing lessons he learned the hard way.

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