The Closing Bell
3/29//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 1786-1963
Intermediate
Term Uptrend 1742-2442
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 47%
Aggressive
Growth Portfolio 46%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s data weighed to the plus side: positives---weekly purchase applications,
February new home sales, the January Case Shiller new home price index, weekly
jobless claims, March consumer confidence, the March Chicago National Activity
Index, the March Kansas City Fed manufacturing index, February personal income
and fourth quarter 2013 corporate profits; negatives---weekly mortgage applications,
February pending home sales, the March flash PMI and the March Richmond manufacturing
index; neutral---weekly retail sales, the February combo of durable goods
orders and orders, ex transportation, February personal spending, March consumer
sentiment and revised fourth quarter 2013 GDP growth and price index.
This heavy
leaning towards a more upbeat economic outlook provides another step up in
confidence that weather was indeed the primary driver in the recent deterioration
in the numbers and that our forecast remains on track. I must admit that the durable goods orders,
ex transportation is a little concerning but it was offset by the preponderance
positive data. The warning light will
likely stay lit for another couple of weeks but the trend in the economic stats
is clearly encouraging. 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.’
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a
vulnerable global banking system. In
addition to passing last week’s Fed stress test, this week most of the banks
received approval for the dividend and stock buyback plans. As I noted last
week, it would be a shock if banks’ financial condition weren’t improving given
Fed’s largess in providing a continuing free interest rate arbitrage. That said, before tip toeing through the
tulips, I would encourage you to bear in mind that the banks still have massive
counterparty risk via their exposure to derivatives. In addition, the regulators thought that they
had the financial system’s risk management under control in 2008 [because Ben said
exactly that]; and we know how that turned out.
‘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. our political elite continue to keep a low
profile save for the ongoing disaster that is Obamacare and Obama’s proclivity
for pontificating [this time to Russia] versus really doing something. As I have said before, I think it likely that
the mischief level will remain low for the remainder of the year as the ruling
class focuses on electioneering versus doing anything to help the economy.
(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.
Little was done
this week to alleviate the confusion over the time table of the Fed’s
transition policy. In individual
speeches, dovish member sounded more hawkish and vice versa to the point where
investor whiplash was obvious. I still
think that the Fed is totally perplexed about how extract itself from QEInfinity
and that raises the risk that it will bungle the transition.
That said, 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.
Thoughts from Rick Santelli (2 minute
video):
(4)
a blow up in the Middle East or someplace else. The diplomatic turmoil over Ukraine’s future
continues even as Putin consolidates his Crimean acquisition. The problem is the turmoil is mostly rhetorical
versus anything substantive. The sanctions imposed thus far have been less than
a hand slap. Meanwhile, Putin is building
Russian military forces on the eastern Ukrainian border and strengthening relations
with China and India as an offset to any meaningful sanctions---were they to
come.
Jim Rogers on the
sanctions (medium):
I repeat my
bottom line, outlined in Thursday’ Morning Call: ‘If He [Obama] would actually
do something (pledge to reinvigorate NATO, resume negotiating the treaties with
Poland and the Czech Republic) to project American power and show Putin that He
is dead serious about preventing further expansion from Russia, I could get
behind the Guy. Sure it would likely
send nervous tremors through the Markets---but it would be a long term
positive. But trying to scare Putin with
a lot diplomatic bullshit accomplishes nothing because Putin doesn’t care and
doesn’t respect Obama enough to think that anything He does will materially
impact Russia. Indeed as I have voiced
many times, my concern is that Putin responds to these antics by kicking Obama
in groin, humiliating Him publicly. I
suspect that the Markets would be even less enthralled with this scenario.’
Meanwhile,
Putin called Obama yesterday afternoon---though there are dramatically
different accounts of what was said (medium):
(5)
finally, the sovereign and bank debt crisis in Europe and
around the globe. The EU addressed the solution
to its problem this week when the ECB proposed easing monetary conditions by
imposing negative interest rates and increasing its willingness to buy the
toxic assets currently housed in the EU banking system. I am not sure the latter solves any problems
in that all that would change is the location of a nonperforming asset. Indeed, if the new liquidity provided to the
banks is used to buy more sovereign debt of insolvent sovereigns, then matters
will have gotten worse.
Because the
banks certainly aren’t lending money to corporations or individuals (medium):
In addition,
the financial turbulence in China is only getting worse. This week’s events include bank runs, shrinking
credit availability and a declining yuan and stock market. To its credit the Bank of China has thus far managed
this crisis reasonably well---the risk, of course, being that problems simply
overwhelm it.
Bottom line: the economic data continues to improve from a
month ago. As a result, I believe that it is likely that our forecast is on
track though I am going to wait another week before switching the warning light
off.
Fed policy remains
somewhat confusing with the hawks sounding like doves and the doves sounding
like hawks this week. I continue to view
this as weakness though there is a case to be made that the Fed is becoming
more aggressive in its attitude toward the transition to normalized monetary policy. Either way, I believe that the odds have gone
up that the Fed will bungle the transition.
On the other hand, I am partial to a faster move to the tightening
alternative for the simple reason that the inevitable economic and Market pain
will be less, the quicker the process begins.
The Chinese
central bank continues its policy of re-introducing ‘moral hazard’ into the
investment equation. To its credit, it
has managed the process reasonable well to date. Plus yesterday, a high ranking Chinese
official made noises about the government instituting a stimulus program. That wouldn’t solve the long term problem
but it would paper over it in the near term.
The weak EU and
Japanese economies are also areas of concern.
The ECB is talking like it may impose negative interest rates on bank
reserves and/or buy a slug of the toxic assets that remain on bank balance
sheets---dreaming that what hasn’t worked in the US or Japan will somehow work
there.
And this from
Japan (medium):
Finally, a flare
up Ukraine would likely put upward pressure on oil prices which would in turn
negatively impact the global economy. I
keep thinking that the US won’t do anything stupid enough to precipitate such
an outcome and then I watch Obama yakking on the six o’clock news and have my
doubts.
In sum, there
are a lot of potential problems overseas lurking in the weeds that could
disrupt global economic growth but they have thus far been contained. So I leave my ‘muddling through’ scenario in
place with the warning light flashing.
This week’s
data:
(1)
housing: weekly mortgage applications declined while
purchase applications rose; February new home sales dropped less than forecast;
February pending home sales were down but in line; the January Case Shiller home
price index increased slightly,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims fell more than estimates; March
consumer confidence was quite strong while consumer sentiment was in line,
February personal income was slightly above consensus while personal spending
and the price deflator were right on,
(3)
industry: February durable goods orders advanced more
than anticipated but ex transportation, they rose less; the March Chicago Fed
National Activity Index came in better than expected while the March flash PMI
was worse; the March Richmond Fed manufacturing index decreased more than
consensus while the Kansas City Fed index was much improved,
(4)
macroeconomic: revised fourth quarter GDP growth came
in at 2.6% versus estimates of 2.7%; the price deflator was 1.6%, in line; and
corporate profit growth was +6.0% versus forecasts of +5.6.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16323, S&P 1857) had another volatile week. They followed a pattern of being up strong in
the morning and then giving most if not all of it back by the close. For the week, the Dow was up fractionally and
the S&P was off.
The S&P
closed within uptrends across all timeframes: short (1786-1963), intermediate
(1742-2542) 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
fell; breadth improved after a tough week.
The VIX declined. It continues to
offer no directional help with the Market, finishing within its short term
trading range and intermediate term downtrend and right on its 50 day moving
average.
The long Treasury
busted through the upper boundary of its short term trading range this week,
though it fell on Friday. While it
remained above the upper boundary of its short term trading range for the
requisite period under the time element of our discipline, Friday’s decline was
big enough that I am delaying until Monday the call to re-set the short term
trend to up.
However, if it
holds it will be doing so in the face of overwhelming stock Market opinion that
the economy is improving---not an occasion that is usually accompanied by
falling interest rates. The most obvious
scenarios conducive to a price advance are (1) recession/deflation or (2) a
flight to safety [think Ukraine]. Neither makes a lot of sense given the news
flow. So either the bond guys think that
they know something the stock guys don’t or there is some technical factor that
will be soon corrected (part of the reason I am waiting another day to make the
break out call).
GLD continued
its short term sell off, finishing within a short and intermediate term downtrend
and below its 50 day moving average.
Clearly, any thoughts about nibbling have been shelved. I am now watching how GLD handles its double
bottom lows (lower boundary of its long term trading range).
Bottom line: it was a volatile sideways week. But the bulls won the last hole, so they have
the honor. Barring bad news out of one
of our potential risk areas (Japanese economy, EU economy, Chinese financial markets,
Ukraine), the price direction is flat to up.
That suggests at least a try at penetrating the upper boundaries of the
Averages long term uptrends. However,
given the growing number and magnitude of divergences, I believe that they will
hold.
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 (16323)
finished this week about 39.8% above Fair Value (11675) while the S&P (1857)
closed 28.2% 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.
This week’s
economic stats once again reflected our forecast. Nonetheless, as I noted above, I am leaving
the yellow light flashing at least for another week or two. Of course, as long as investors’ mentality is
that good news is good news and bad news is good news, I am not sure the
economy matters to the Market in the near term scheme of things---although I do
suspect that a full-fledged recession accompanied by deflationary pressures
would tighten some sphincters. Importantly
though, the fact that economy is not going into recession doesn’t impact our
Models at all. In other words, a slow
recovery is built into our numbers; and the fact that it is looking more likely
than a month ago has no effect on stock values.
Tapering for
pussies continues apace; but the longer term course of Fed policy remains
uncertain. As I noted above, neither
time nor additional comments from multiple FOMC members have brought any
clarity. I believe this a sign that the
Fed doesn’t have a clue how to unwind its record monetary expansion which in turn
means that the probability of it mucking up the transition is even higher than I
originally suspected. All that said, there
is an alternative scenario and that is that Yellen is dead serious about
tightening faster than any of us thought.
That would probably not be well received by the Markets though cumulatively,
it would be the less painful alternative.
Finally, the
risks are growing for potential negative events overseas. China heads the list as its economy slows and
its financial markets are going through a massive deleveraging. So far the Bank of China has successfully
contained the damage; but the risk is that it gets overwhelmed. Japan and to a lesser extent the EU are
having problems getting any economic growth.
Japan is in much worse shape in that it has far fewer policy levers to
pull in as much as Abe has already made our Fed look like a bunch of
pikers. The major risk to the securities
markets from both China and Japan is the unwinding/repricing of their carry
trade.
Ukraine is like
a bad case of the herpes---you can’t get rid of it. Obama
is walking around like a deer in the headlights while Putin is boppin’ n jivin’
and handing out high fives like he just won the Super Bowl. Meanwhile he builds up the military on
Ukraine’s eastern border, imposes his own sanctions and cuts trade deals with
the Chinese and Indians. 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 punched in the face. My guess is that neither would be well
received by the Markets.
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.
For
the bulls (medium):
Counterpoint from Seth Klarman
(medium):
Chinks in the armor (medium):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 3/31/14 11675 1449
Close this week 16323 1857
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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