The Closing Bell
3/22//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 Uptrend 1781-1958
Intermediate
Term Uptrend 1734-2434
Long Term Uptrend 739-1910
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 light week for data; what we got was mixed: positives---February building
permits, weekly jobless claims, the March Philly Fed manufacturing index; February
industrial production and capacity utilization, the 2013 fourth quarter current
account deficit; negatives---weekly mortgage and purchase applications,
February housing starts and the March NY Fed manufacturing index; neutral---weekly
retail sales, February existing home sales, the February and revised January
leading economic indicators and February CPI.
What was notable
this week was:
(1) the
general trend of the stats appears to have returned to mixed to positive: while it is still probably a bit too soon to
declare the economy back on course, it does appear to be coming through the
weather induced period of lousy numbers in decent shape. I am leaving the yellow light flashing but it
is not quite as bright as before,
(2) the
FOMC meeting, policy statement and subsequent Yellen news conference caused
quite a stir on Wednesday. I covered the
subject in Thursday’s Morning Call; but in summary, I believe [a] that Yellen’s
more hawkish tone was an unforced error and likely inaccurately portrayed her
true intent and [b] ‘qualitative guidance’ is a sign of weakness and
uncertainty within the Fed as to how to extract itself from the untenable
position {massive balance sheet} in which it has placed itself and increases the
already substantial odds of it bungling the transition process.
As I noted
above, I keep the warning light flashing though it appears that it will again prove
a false warning and leave our forecast unchanged:
‘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
The
negatives:
(1) a
vulnerable global banking system. This
week JP Morgan agreed to sell its commodities trading unit---a positive step in
de-risking its balance sheet. Meanwhile,
UBS is being investigated for manipulating the London gold price fix:
In addition,
the Fed released the results of its latest bank ‘stress test’ this week. I covered this in our Morning Call; but in
summary (1) after all the free money the Fed has given the banks, it is no
surprise that they are in better shape, (2) the Fed has no way of calculating
the counterparty risk in the banks’ derivative trading and (3) the problem with
insolvency is not the prevailing regulations or their monitoring, it is in the
people administering the regulations and monitoring. As a final note to this item, after the Market
close Friday, the Fed released a ‘revised’ stress test:
‘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. Congress is on vacation; so the mischief level
is now low, at least temporarily. On the
other hand, we did get some electioneering on the familiar cost cutting, tax
reform rhetoric from the GOP---which they have made little attempt to implement
beyond lip service. Oh wait, they did
manage to hornswoggle Obama into the sequester which Paul Ryan then negotiated it
away. The bad news is that this is probably a sign of what is to
come from our ruling class for the rest of this year, i.e. a lot of positioning
for the election with no real intent to do a bloody thing to actually help the
economy or taxpayers.
(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.
As I noted
above and in more detail in Thursday’s Morning Call, I think that ‘qualitative
guidance’ is an admission that the Fed has no clue how to extract itself from
its horrendously easy monetary policy and is trying to obfuscate the fact by
attempting to dazzle us with a lot of technocratic bullshit. This only increases the odds of future
economic problems resulting from a botched transition to normalize monetary
policy.
That said, I was
surprised that FOMC member Bullard on Friday reinforced Yellen’s comments on the
timing of an interest rate increase---which got me thinking [I know, that’s
dangerous] that maybe Yellen meant everything she said, that the obfuscation
from removing the unemployment rate as a visible quantitative guideline was
done to confuse the Markets and that the Fed really is intent on ending QE and
moving rates up on a more rapid timetable than most think. I don’t think that the case is overwhelming;
but I don’t think that we dismiss the possibility out of hand. It is certainly something that I will be
watching.
I would love to
eat crow on my initial FOMC/Yellen conclusions.
To me, the quicker the Fed starts to unwind its ultra easy monetary
policy, the less pain the economy and the Markets will have to endure---and to
be clear, I think that there will be pain especially in the securities
markets. But every drunk has to sober up;
better to start the hang over now than wait and feel even worse.
And this from Citi (medium and a must
read):
(4)
a blow up in the Middle East or someplace else. The turmoil in Ukraine is subsiding as the
rest of world recognizes the Russian annexation of Crimea as a fait accompli. We should all be very proud of the US
response---a lot of ‘sharply worded warnings’ and sanctions imposed on seven
rich Russians [Friday afternoon it rose to 33].
I feel reasonably sure that Putin and his cronies are laughing their
collective asses off at our political ineptness. On the other hand, I am not sure the whole
affair is over in that [a] once an aggressor realizes that he can invade and
conquer adjacent lands with relative impunity, he tends not to stop and [b]
Putin’s oft quoted statement that the greatest tragedy of the twentieth century
was the dissolution of the Soviet Union.
(5)
finally, the sovereign and bank debt crisis in Europe and
around the globe. The potential for an
international financial crisis has grown to include more than just Europe. Indeed, the immediate focus in now on Japan
and China. Again, I have covered the
developments in these two countries ad nauseum in our Morning Calls, so I don’t
want to be repetitious. The bottom line
though is that problems are starting to arise from overly expansive monetary
policies particularly as they relate to what has become a ginormous global
‘carry trade’ that appears to be starting to unwind---the result of which could
be a major haircut to asset prices.
And:
Bottom line: the economic data continues to improve from a
month ago. It appears that the weather
was merely a temporary setback. But I would
like a couple more weeks of upbeat numbers before declaring our forecast intact
and switching the warning light off.
Fed tapering policy
was affirmed by the FOMC this week though it managed to inject ‘qualitative
guidance’ into monetary policy. I
interpret this as a sign that the Fed is getting very nervous about its ability
to transition to tighter money and wants to give itself the ability to conceal
that uncertainty---though there is an argument that it was intentional and the
transition is moving forward at a faster pace than most expected. Something we have to pay attention to.
The Chinese
central bank continues its policy of re-introducing ‘moral hazard’ into the
investment equation. This week, two more
corporations were allowed to default and the yuan continues to depreciate. Whether this marks the beginning a global
unwind of the ‘carry trade’ remains to be seen; but it is clearly going forward
in China. The one mitigating
circumstance is that the Bank of China has thus far managed to prevent an
economic crisis. Unfortunately, the same
can’t be said for the securities markets as the Chinese equity market slipped
into a bear market this week. This whole
process could potentially be pointing to our own future, in that, the crisis is
occurring in the markets not in the economy.
That leaves me sticking to my ‘muddle through’ economic scenario but
flashing the caution light for the markets.
This week’s
data:
(1)
housing: weekly mortgage applications and purchase applications
fell; February housing starts were much worse than estimates though building
permits improved; February existing home sales were off 0.4%, in line,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims rose less than estimates,
(3)
industry: the March NY Fed manufacturing index was
below consensus while the Philly Fed index was well above its forecast;
February industrial production and capacity utilization was better than
expected,
(4)
macroeconomic: the February leading economic indicators
were ahead of estimates but the January number was revised down; February CPI
was up slightly, in line; the fourth quarter 2013 current account deficit was
less than anticipated.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16302, S&P 1872) had a volatile week, though they managed to
finish in the plus column. The S&P
closed within uptrends across all timeframes: short (1781-1958), intermediate
(1734-2534) and long (739-1910). The Dow
remains within short (15330-16601) and intermediate (14696-16601) term trading
ranges and a long term uptrend (5050-17400).
They continue out of sync in their short and intermediate term
trends---which leaves the Market trendless.
Volume on Friday
was huge due mainly to options expiration; breadth was terrible. The VIX rose but continues to meander within its
short term trading range and intermediate term downtrend.
The long Treasury
was strong after getting slapped around for much of the week. As you know, I thought
it negative that it couldn’t break above the top of its short term trading
range (now a triple top). However, there
wasn’t much of a follow through to the downside; plus it remains above its 50
day moving average. So there remains a
chance that the long bond could break to the upside. Such a move would indicate coming economic
weakness or the US as a safe haven if crises break out elsewhere in the world.
GLD sold off big
this week but stopped right at the lower boundary of its very short term
uptrend and then bounced on Friday.
While it remains within short and intermediate term downtrends, if
Monday is another up day, our Portfolios will likely start to nibble. A break above the upper boundary of its short
term downtrend would then be a signal to add to the holding. GLD also finished within an intermediate term
downtrend.
Bottom line: the bulls are still in control. They were challenged but overcame Yellen’s ‘six month’ comment as well as
continuing deterioration in the Chinese and Japanese markets brought on by the
unwinding of the ‘carry trade’ in both currencies. So
despite having a trendless market as well as growing technical divergences,
there appears to be enough residual strength to keep prices advancing toward
the upper boundaries of their long term uptrends. However, I still believe that those upper boundaries
will prove too formidable to be successfully challenged.
Meanwhile, we
have a trendless Market; 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.
Market performance in mid-term
election year (short):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (16302)
finished this week about 39.6% above Fair Value (11675) while the S&P (1866)
closed 28.7% overvalued (1449). 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 and China.
The economic stats
are starting to once again reflect our forecast. However, I am not quite convinced that all is
well, so I am leaving the yellow light flashing. If the past year is any guide, investors are
likely to react positively to a more certain economic environment. But since that is already in our Models, I am
not going to discount it twice. On the
other hand, if the recovery is not intact, the Market is apt to react
negatively.
Tapering for
pussies continues apace; and given Yellen’s ‘slip’ at her news conference, I suppose
that there is some probability that interest rate hikes will begin next year. At the moment, I have a slightly more
jaundice view of the latest Fed actions.
The ditching of the unemployment rate as a guidepost to transition and the
adopting of ‘qualitative guidance’ in its stead suggests to me that the Fed has
no idea how to execute a smooth transition process and so it is obfuscating
that uncertainty by removing any quantitative standards against which its policy
can be judged. That raises the already substantial
odds that it will again fail.
Finally, China is
growing as a potential sources of investor cognitive dissonance. Their securities market are already reflecting
the pain of re-introducing ‘moral hazard’ into the investment equation. There is some risk that its effects will be
transmitted to the international markets via a dramatic repricing of the ‘carry
trade’. That risk is likely heightened
by similar problems in the Japanese markets.
So far US markets have escaped any fallout; the risk clearly being that
it won’t last.
Ukraine seems to
be receding as a potential threat to our markets as (1) Putin consolidates
Crimea and (2) Obama continues His limp wristed attempt at sanctions. The risks are that (1) Russian minorities in
eastern Ukraine are suddenly ‘targeted’ for persecution and ask for Putin’s
help or (2) Obama pushes His luck, pisses Putin off and gets bitch slapped for
all to see. My guess is that neither will be well received by the Markets.
Or maybe there
is a third risk (medium):
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 and the risks that they might
are diminishing.
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.
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 3/31/14 11675 1449
Close this week 16302 1866
Over Valuation vs. 3/31 Close
5% overvalued 12258 1521
10%
overvalued 12842 1593
15%
overvalued 13426 1666
20%
overvalued 14010 1738
25%
overvalued 14593 1811
30%
overvalued 15177 1883
35%
overvalued 15761 1956
40%
overvalued 16345 2028
45%overvalued 16928 2101
Under Valuation vs. 3/31 Close
5%
undervalued 11091 1376
10%undervalued 10507
1304
15%undervalued 9923 1231
* 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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