The Closing Bell
2/15/14
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 Trading Range 15330-16601
Intermediate Uptrend 14696-16601
Long Term Uptrend 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 Trading Range 1746-1858
Intermediate
Term Uptrend 1711-2391
Long Term Uptrend 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. It was
a slow week for economic data and what
we got was basically mixed---though the more important stats were negative: positives---small
business confidence, consumer confidence, wholesale inventories and sales and
the January budget deficit; negatives---weekly mortgage and purchase
applications, December industrial production and capacity utilization, January retail
sales and weekly jobless claims; neutral---weekly retail sales
As I noted
above, while the data flow was uneven, the numbers everyone is worried about
were disappointing---mortgage applications, retail sales, industrial production
and employment. This clearly keeps the
yellow light flashing. That said, the
weather remains a complicating/mitigating factor. As I noted last week, while I accept that it
is having an impact, I am not sure if it is otherwise hiding/exacerbating a
slowdown already in progress. Until we
get a better feel for whether or not these weak figures are weather induced,
our outlook will remain:
‘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.’
Update on the big four
economic indicators (medium):
The pluses:
(1)
our improving energy picture. The US
Obama’s energy
moment (medium):
The
negatives:
(1) a vulnerable global banking system.
JP Morgan does it again:
As did another bailed
out bank (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. This week’s notable events were:
[a] Obama raising
the minimum wage for all federal contractors by executive order,
[b] congress raising
the debt ceiling. While this will avoid the prior Market disrupting wrangling
over government spending, it clearly does nothing to address the issue long
term. Fiscally irresponsible spending,
exemplified recently by the Farm Bill and new estimates of the impact of
Obamacare, along with over regulation [minimum wage] and over taxation remain a
burden to this economy. Any hope of
economic growth returning to its former secular rate is largely dependent on lightening
these millstones,
[c] in a
surprising, little discussed and potentially very positive development, the CBO
has altered its method of analyzing the national budget---switching to what is
called ‘dynamic scoring’ which attempts to
account for likely taxpayer responses to fiscal measures. The easiest example is a tax increase/decrease. Before the assumption was that the increased/decreased
rate would simply be applied to the current level of earned income yielding an
increase/decrease in taxes collected. The
new dynamic accounts for potential taxpayer response: working less/more, altering
accounting treatments to decrease/increase declared income, etc. The importance being that now any proposed tax
cut will not reduce assumed tax receipts to the extent they did under the old
methodology. Hopefully this will make
reforming the tax code a bit easier.
(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.
Yellen held
center stage this week as she made her first appearance before congress as Fed
chief---and she didn’t disappoint the doves.
Her comments clearly pointed to tapering for pussies remaining policy and
suggested that it could become even less of a threat to the Markets if the
economic data continue to be troublesome.
It is certainly
too early to start characterizing the policies that will flow from her regime.
But the initial take is that the Yellen Fed will remain every bit as easy as
the Bernanke Fed. That clearly does
nothing to lessen the risk of an overly accommodative monetary policy.
The issues
remain: [a] can the Fed successfully transition from easy to tight money
without bungling the process---which it has done at every other such juncture
in its history? [b] from an economic
standpoint, since QEInfinity had little effect on economic activity during its
tenure, will it have an impact being unwound?
[c] from a Market standpoint, since asset prices are where the impact of
QE has been felt the most, isn’t reasonable to assume that it is the Markets that
will have to pay the price for the Fed’s monetary experiment.
(4)
a blow up in the Middle East . Quiet.
(5) finally,
the sovereign and bank debt crisis in Europe . Draghi’s remarks notwithstanding, the data
out of Europe this week was not that positive.
Of course as I often note, one week doesn’t a trend make. Those numbers could just be statistical noise
or perhaps the weaker US performance along with the continued sluggishness in
the emerging markets are taking their toll.
In any case,
this risk is less about EU economic growth and more about the leveraged state
of the EU banking system, the [low] quality of those leveraged assets and the
risk that some exogenous event could push one or more banks into insolvency.
****I apologize
for all the must reads below; but they are.
Those potential
exogenous events would include a currency crisis in an emerging market, the
continued importation of deflation from Japan, a credit crisis in China or
something closer to home.
And (must read):
And (must read):
On the latter
point, a debate within the EU this week centered on the implications of the
German high court’s ruling on ECB’s ability to back stop the liquidity of the
banks. I have no idea how this issue
resolves itself; but I do know that guys far more knowledgeable than me are not
in agreement---that spells ‘risk’ to me.
http://www.marketwatch.com/story/euros-fate-is-now-in-germanys-hands-2014-02-13?siteid=rss&rss=1 also a must read
Bottom line: the economy continues to grow sluggishly though
the data is becoming increasingly worrisome.
I do believe that some of the shortfall in expectations can be
attributed to weather; I am just not sure how much. For the moment, I leave our forecast
unchanged; though the warning light is flashing.
The ruling class
remains on script which is to say promise responsible fiscal policy and deliver
something else. Part of the reason that
the Fed has gotten its dick in the wringer is trying to carry the economy in
the absence of adult behavior from the politicians. Unfortunately, nothing happening that would
suggest a change in congress or the white house.
The outcome of
tapering for pussies became a bit more cloudy this week with Yellen’s testimony,
i.e. the Fed’s intent to follow through is a bit more suspect. To be fair to her, part of this was more a
function of how the Market interpreted what she said than what she actually
said---that is, while she sounded dovish, investors assumed more dovish
implications than were actually stated.
We will know
soon enough just how dovish she is.
Meanwhile, Yellen is stuck with a Herculean task of unwinding QE without
causing economic disruptions. If she is more dovish than Bernanke and tapers or
reverses the taper as a result of the poor economic stats, then she will just
dig a bigger hole for the Fed to climb out of.
If not, history is still not on her side, i.e. the Fed has never
successfully transitioned to tight money.
And that ignores the possibility that the Markets will get sick and
tired of tapering for pussies and take matters into their own hands.
The economic
news out of Europe was a bit more mixed this week. The situation wasn’t helped by the generally
punk news from around the globe (Chinese investment trusts defaulting, Italian
government falls, German court decision raises questions about EU QE, Japanese
deflation, political unrest in Venezuela, Turkey and Kazakhstan, etc.). I am
leaving the ‘muddle through’ scenario in place.
But the international economic/political risks are growing.
This week’s
data:
(1)
housing: weekly mortgage applications and purchase applications
fell,
(2)
consumer: weekly
retail sales were mixed while January retail sales were disappointing; weekly
jobless claims rose more than estimates; the initial February University of
Michigan consumer sentiment index was better than forecast,
(3)
industry: December industrial production and capacity
utilization were below expectations; the January small business confidence
index rose; December wholesale inventories were up less than expected but more
than sales,
(4)
macroeconomic: the January budget deficit was less than
anticipated.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16150, S&P 1838) tip toed through the tulips this week, spurred
by Janet Yellen’s first testimony before congress and helped by some short
covering on Friday. However, they
remained within their short term trading ranges (15330-16601, 1746-1858). The Dow closed within its intermediate term
trading range (14696-16601) but broke above its 50 day moving average, while
the S&P is in an intermediate term uptrend (1711-2491) and above its 50 day
moving average. Both are in long term
uptrends (5050-17400, 728-1900).
Volume was low,
as it has been all week; breadth was mixed---a bit surprising for such a strong
upward price day. The VIX was down, ending
within its short term trading range and intermediate term downtrend and closing
below its 50 day moving average.
I checked again
on our internal indicator---judging our stocks versus the S&P in terms of
proximity to their former all time highs.
In a 153 stock Universe, 41 are approaching or have surpassed their former
highs while 112 remain 3% or more away from their highs.
The long Treasury
was up fractionally, finishing within a short term trading range and an
intermediate term downtrend. It
continues to build a head and shoulders formation.
GLD put on
another great performance (+1.3%). It is
now well above the lower boundary of that very short term uptrend; in fact, it
is getting a bit ahead of itself. It remains
with both a short and intermediate term downtrend. I am waiting to see where GLD will encounter
support on its next sell off.
Bottom line: the bulls controlled the board this week. However, volume on the rally was low, breadth
was mixed, the price action of the Averages is not being supported by our
internal indicator, plus they are facing the resistance of a double top and
there was a good deal of short covering on Friday.
That said, price
is truth and right now prices are sizzling.
Clearly, the next important technical juncture will be at the 16601,
1858 level. I wait with bated breath.
Meanwhile, we
have a Market in a trading range; so there is really not much to do save using
any price strength that pushes one of our stocks into its Sell Half Range and to
act accordingly.
For the bulls (medium):
Technical
thoughts from Citi (medium):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (16150)
finished this week about 38.6% above Fair Value (11650) while the S&P (1838)
closed 27.1% overvalued (1446). 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 dataflow, especially
in the primary sectors of the economy, remains weak. Weather is being argued as a major mitigating
factor; and I tend to agree with this analysis.
However, the lousy numbers can’t be summarily dismissed. Nor can we assume that the Fed will make
everything alright if the economy does deteriorate. Indeed, if recent history is any guide, suspending
or even reversing tapering will do little to stimulate economic activity.
The debt ceiling
was raised this week which should allow us to avoid the gutting wrenching
Market adjustments that the past fights have caused. Don’t take that as particularly positive
assessment. It is probably good for the
Markets short term but does nothing to alter irresponsible spending, taxing and
regulatory policies. As such, Washington
will remain a drag on economic growth.
Having said
that, the bureaucrats actually did us all a favor this week---the CBO moving to
a dynamic scoring process on the budget.
By itself it does nothing because the politicians have to propose responsible
budget measures to be scored in the first place. However, it does take away the arguments of
the more progressive members of congress that want more and more taxes. We can only hope.
The recent signs
of economic weakness raise an interesting question with respect to monetary
policy: will a dovish Fed use these numbers as an excuse to taper the tapering
and amplify the already extreme policy measures that it has taken since 2007 to
stimulate the economy?
To do so in my
opinion would be a major negative and would only magnify the risks associated
with managing a successful transition to tighter money. Furthermore, the evidence of QE’s impact on economic
growth is questionable. That might not
stop it from tapering or reversing the tapering; but that policy would be
unlikely to help many save investors.
Perhaps the real question is, will the Markets be patient enough to
allow the Fed to tinker with its previously stated policy?
Overriding all
of these considerations is the cold hard fact that stocks are considerably
overvalued not just in our Model but with numerous other historical measures
which I have documented at length. This
overvaluation is of such a magnitude that it almost doesn’t matter what occurs
fundamentally, because there is virtually no improvement in the current scenario
(improved economic growth, responsible fiscal policy, successful monetary
policy transition) that gets valuations to Friday’s closing price levels. Indeed, the problem is that any revision in
the economic outlook from here is more likely to be negative than positive.
Bottom line: the
assumptions in our Economic Model haven’t changed, though the risks are rising
that they might.
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.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 2/28/14 11650 1446
Close this week 16150 1838
Over Valuation vs. 2/28 Close
5% overvalued 12232 1518
10%
overvalued 12815 1590
15%
overvalued 13397 1662
20%
overvalued 13980 1734
25%
overvalued 14562 1806
30%
overvalued 15145 1878
35%
overvalued 15727 1951
40%
overvalued 16310 2023
45%overvalued 16892 2095
Under Valuation vs. 2/28 Close
5%
undervalued 11067 1373
10%undervalued 10485
1301
15%undervalued 9902
1229
* 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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