The Morning Call
The Market
Technical
The
indices (DJIA 15884, S&P 1786) rallied strongly yesterday from an oversold
position. They closed within uptrends
along all timeframes: short term (15542-20542, 1752-1906), intermediate term (15552-20542,
1657-2238) and long term (5050-17400, 728-1900).
Volume
rose slightly; breadth improved.
Surprisingly, the VIX rose on the big up day, suggesting that despite
the positive pin action, investors were also buying Market protection.
The
long Treasury fell, remaining within a short term trading range and an
intermediate term downtrend. It
continues to build a head and shoulders formation.
GLD
was up but finished within short and intermediate term downtrends.
Bottom
line: yesterday’s rebound was partly a
function of the Market being oversold, partly a function of the Market’s
positive seasonal bias and partly a change in investor psychology which seems
to have shifted from fear of tapering to rejoicing at no tapering.
17400/1900
remain my best guess at the potential upside from here. Given that it is somewhat limited, I see no
reasons to chase stocks from here and, in fact, I will continue to use the
current advance as an opportunity for our Portfolios to take advantage of our
Sell Price Discipline.
Fundamental
Headlines
Yesterday’s
economic news was generally upbeat: third quarter nonfarm productivity was better
than expected while November industrial production was almost double estimates;
the December Markit flash PMI was just
slightly below forecast. The only real
downer was the December NY Fed manufacturing index. All in all, the data provided evidence that
the economy remains in good shape and that there is little risk of an economic
downturn.
Overseas,
the stats were mixed with the eurozone flash PMI
coming in better than anticipated while the Chinese flash PMI
was disappointing.
The
economic numbers particularly industrial production certainly provided a
fundamental reason for stocks to rally. This
was aided by an apparent change in attitude regarding tapering, i.e. it won’t
begin following this week’s FOMC meeting.
As you know, I never thought there was much chance of this happening; so
it is not surprising to see sentiment swing in that direction. When coupled with the seasonal bias, it is
also not surprising that stocks would be rallying.
However,
I have issues with stocks going into the wild blue yonder: (1) I believe that
the economy is fine, stocks are just valuing it richly. At some point this disconnect will be
rectified and (2) QE will have to end, sooner or later; given that monetary
policy is in uncharted territory, there are risks of unintended consequences;
we just don’t know the order of magnitude; the longer QE goes on, the greater
the likely magnitude of those unintended consequences. It may be that the Fed finesses the tapering
and nothing bad occurs. History says
that won’t happen. But until we know,
caution has to be part of investment strategy
Bottom line: our
Valuation Model depicts stocks as considerably overvalued even with an
improving economy and ignoring any possible negative fallout from an unwinding
in QE. It is the latter factor that
poses the real Market problem.
Stocks can stay
overvalued for lengths of time as long as the economic fundamentals are improving. They adjust to Fair Value when some exogenous
event occurs that gives the Market a reality check. I think that it is very reasonable to assume
that it will be the transition process from easy to tight money that provides
that reality check---not because the transition itself is an exogenous event. Clearly it is not. But the preponderance of pundits either
dismiss the probability of tapering as an event not likely to occur in our
lifetime or assume that the genius’ in the Fed can manage the transition from
easy to tight money in a way to effectively avoid any negative
consequences---something that it has never done in its history. Neither will likely occur and that is your
exogenous event.
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
Markets are not ready for a rise in short term interest rates (medium):
Three
reasons for a global dividend growth strategy (short):
The
latest from John Hussman (medium):
Investing for Survival
2013
lessons learned (medium):
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