The Closing Bell
3/8//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 1746-1848
(?)
Intermediate
Term Uptrend 1725-2405
Long Term Uptrend 728-1910
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. At
last, we finally had a week where the preponderance of the data was upbeat: positives---weekly
mortgage and purchase applications, January personal income and spending, weekly
jobless claims, January nonfarm payrolls, the February Markit PMI, February ISM
manufacturing index, January construction spending, February retail chain store
sales and the tone of the latest Fed Beige Book report; negatives---the February
ADP private payroll report, the February ISM nonmanufacturing index, January
factory orders and fourth quarter productivity and unit labor costs; neutral---weekly
retail sales, the January trade deficit and February light vehicle sales.
What was notable
this week was:
(1) the
general trend of the stats turned positive.
I don’t think that we can assume that the worst is over. But it is a positive sign that the latest
round of lousy numbers could be just another of the many hiccups the economy
has experienced since 2009. That said,
it is far too early to be making that call.
So for the moment, I think that we have to settle for being thankful the
data didn’t get worse,
(2) I
noted in a couple of this week’s Morning Calls that I was a bit surprised by
the tone of the most recent Beige Book report, that is, it sounded more upbeat
than I thought warranted by the recent string of poor economic data. Don’t get me wrong, I am pleased that the Fed
is sticking to its guns. I just thought
the Fed would use the excuse of lousy stats to hedge its tapering policy. As it stands, all systems are go; and while I
think them inadequate, they are at least a step in the right direction.
All that said,
one week’s data is not going to settle the issue of the underlying rate of
economic growth and whether or not weather is masking developing weakness. So I keep the warning light flashing hoping
that it will again prove a false warning and leaving 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.’
Update on the big four
economic indicators (short):
Inequality
and a sluggish economy (medium):
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a
vulnerable global banking system. No new
examples of bankster misdeeds this week [surprise, surprise]. However, I do include this editorial on the
ruling class/bank cronyism, the economic disservice it perpetrates and why I remain
concerned about a banking system that is not nearly as sound as we are led to
believe (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. Obama presented His FY2015 budget this
week---oh wait a minute, His $3.9 trillion FY 2015 budget which includes $1
trillion in new taxes---which is just what the doctor ordered for a struggling
economy. The good news is that it
provided everybody got a good laugh and then was immediately tossed in the shit
can.
The bad news is that it 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.
I noted above
the placid tone of the latest Beige Book report. I assume that means that tapering for pussies
will proceed as planned---which is better news than a lot crawfishing and hand
wringing over the recent spate of disappointing economic numbers. However, it still keeps the Fed balance sheet
expanding [a] despite the evidence that it has done little to no good and [b]
pushing policy to an even loftier level from which to descend.
That leaves us
with a Fed which will have to do something that it has never done before---transition
to normality without bungling the process; and to do so with a balance sheet
that dwarfs anything from the past. That
said, as you know, I am less concerned about a negative impact of any
transition process on the economy [since the ever expanding QE had so little effect]
and mostly worried about the Market reaction [since that is where QE exerted
its most influence].
Must
read comments from Robert Rubin (medium): new
(5)
a blow up in the Middle East or someplace else. while the situation in Ukraine seemed to
improve early in the week with some conciliatory remarks from Putin, the cold
hard fact is that he got what he wanted, i.e. control of the Crimea. Indeed, it now appears that the Crimean parliament
will vote to become a part of Russia---creating a ticklish situation for the US
and EU in that the Crimeans are democratically voting for such a move [self-determination
and all that]. Once again proving that
no one in Washington has a fucking clue about how to play the global
geopolitical game. Now the only question
is, will the administration tend to its own knitting or will it do something
stupid in an attempt to recoup face and give Putin the chance to really hit it
in the mouth.
(6) finally,
the sovereign and bank debt crisis in Europe and around the globe. The economic data in Europe showed a little
improvement this week; and for that we can be thankful. In addition, while the ECB left rates
unchanged, it noted that it may cease sterilizing reserves that it injects into
the money supply [a back door way of easing monetary policy]. That too should help lessen the risk of
sovereign/bank credit problems in Europe.
Update on the
ongoing EU bank stress test (medium and a must read):
However, that could
potentially all be made meaningless by the latest attempts of the Chinese
central bank to get control of the rampant speculation in its real estate and
securities markets. To date, it has been
depreciating the yuan and tightening the money supply in an attempt to disrupt
the ‘carry trade’. Now it has decided to
allow a major corporation to go bankrupt, introducing ‘moral hazard’ into the
Chinese risk/reward calculation for the first time.
Given global bank
trading desks’ exposure to the ‘chase for yield’, this policy could become very
disruptive if it continues---although we really have no idea just how exposed
European [or US for that matter] banks are to the Chinese markets. So the moment, I have no idea how this plays
out [will the central bank chicken out at the first sign of trouble? will this
spill over into other markets?] but we must pay close attention.
Bottom line: the economic data improved markedly this week,
but one week’s data is simply not enough to warrant getting jiggy that a
recession has been avoided. So uncertainty continues to surround our
forecast. The biggest question remains
the impact of weather on the numbers; and with the entire country having had a
bad weather week, it will clearly be a while before we have any clarity. I am encouraged that the latest hiccup in the
data will prove to be just that---a temporary softness with no lasting effects,
so I am staying with our forecast for the moment. Nonetheless, the warning light is still flashing.
Fed tapering policy
received another affirmation this week with the surprisingly upbeat Beige Book
report---though as near as I can tell no one seems to grasp that this could be
the beginning of the end, however modest the beginning. Either that or investors believe that the Fed
will chicken out at the first sign of trouble---which could indeed be the case.
However meek
tapering maybe at the outset or however cowardly the Fed may be in the face of
troubling data, Yellen is still 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.
Two global
situations held center stage this week: (1) the political turmoil in
Ukraine. The current issue is, will the
West do something to antagonize Putin in order save face and get a bloody nose?
And:
Chinese central
bank policy appears to be set to curb excess speculation (Janet are you
watching?). If it follows through, it
will be the first central bank to re-introduce ‘moral hazard’ into the
investment equation since 2009. Whether
this marks the beginning a global unwind of the carry trade remains to be seen. However, at the moment, (1) everyone
apparently knows what the Bank of China is doing, so it should be in stock
prices and (2) the Bank of China has thus far managed to prevent a crisis. So I am leaving the ‘muddle through’ scenario
in place though, like the US, the yellow light is flashing.
This week’s
data:
(1)
housing: weekly mortgage applications and purchase applications
rose,
(2)
consumer: weekly
retail sales were mixed and February retail chain store sales improved; January
personal income and spending were better than expected; February light vehicle
sales were flat; the February ADP private payroll report was worse than
consensus while weekly jobless claims and February nonfarm payrolls were better,
(3)
industry: the February Markit PMI was ahead of
estimates; the February ISM manufacturing index was better than anticipated
while the nonmanufacturing index was worse; January construction spending was
better than forecast; January factory orders were disappointing,
(4)
macroeconomic: fourth quarter productivity improved
less than expected while unit labor costs declined less than estimates; the
January trade deficit was in line.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16452, S&P 1878) had another good week, with the S&P
failing an initial breakout above the upper boundary of its short term trading
range/all-time high but then quickly making another challenge which so far has
held. Indeed under our time and distance
discipline, it will confirm a break at the close on Monday. Nevertheless, even if the short term trend is
re-set to an uptrend, the S&P will still be out of sync with the Dow and
our internal indicator; so the Market as a whole will remain trendless. It continues to trade within intermediate term
(1725-2505) and long term uptrends (739-1910).
The Dow closed
the week within short (15330-16601) and intermediate term (14696-16601) trading
ranges and a long term uptrend (5050-17400).
Volume was
anemic during the week’s entire up move and breadth was mixed. The VIX continued to meander within its short
term trading range and intermediate term downtrend.
The long Treasury
was hit hard this week, suggesting that investors may have decided that not
only will there be no recession but also that economy is going to pick up
steam. That seems a bit of a stretch at
this point; but bond investors have historically been more accurate in their economic
expectations than the stock jockeys. So
this is something to watch.
GLD had a see
saw week but ended basically unchanged---which is to say, well above the lower
boundary of its very short term uptrend.
As you know, I have been awaiting some sort of downside challenge to
this uptrend before deciding on re-entry or not; but it just hasn’t come. It also finished within both a short and
intermediate term downtrend.
Bottom line: the bulls are still control and were aided
this week by an improving economic data flow.
They also shrugged off a number of potentially negative factors
including a Fed that is, for the moment, sticking with its tapering schedule, a
politically, and potentially militarily, troubling crisis in Ukraine, some
pretty aggressive moves by the Chinese central bank to reduce credit expansion
and several significant technical divergences.
So the ball remains in their court and that likely means an assault on
the upper boundaries of the Averages long term uptrends.
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 (16452)
finished this week about 40.9% above Fair Value (11675) while the S&P (1878)
closed 29.6% 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.
The economic
stats brought relief this week with the general pattern positive. Granted it is only one week. But it does provide a hopeful sign that the
latest hiccup in the data was just another temporary phenomena similar to past occurrences
in this recovery. We just need more of
the same for a few weeks to turn the warning light off. If that doesn’t happen, then the Market is apt
to react negatively.
The latest
addition of the Beige Book reflected a remarkably sanguine Fed attitude toward
the economy. I am assuming that means
that tapering is proceeding as planned. In addition, the Market seems to be
equally circumspect about the Fed’s tapering and by extension its ability to
transition from its historically unprecedented QEInfinity to normalcy with nary
a slip. I believe that a bit too casual
given the Fed’s
dismal history of unsuccessful attempts. As you know, I have my doubts that there will
be much economic impact. Rather I believe
that it will largely show up in asset prices.
Obama did submit
His FY2015 budget this week which included $1 trillion in tax
increases---illustrating quite perfectly, I think, my thesis that fiscal policy
will remain a significant headwind to the economy and ultimately corporate
profitability and security valuations.
Not that this budget has a snowball’s chance in hell of passage; it is
really nothing more than a Democrat position paper for the 2014 elections. But then that’s the point, isn’t it? The party controlling the White House and the
senate thinks the best thing for this country is a $1 trillion tax
increase.
To be sure,
investors are discounting the GOP winning the senate in 2014 and the White House
in 2016---and indeed, I think (hope) that is the correct assumption. However, (1) a lot can happen between now and
November, (2) the republican infighting has led to blown opportunities to pick
up seats in the senate for the last two elections, so I don’t think that we can
rule out the possibility of a three-peat, (3) finally, republicans have been
just a fiscally irresponsible when they were in control as the democrats. Assuming that they have changed their stripes
in a leap too far for me. It may occur;
but I think it best to make them prove it before discounting a return to sound management
of the government’s finances.
Finally, China
and Ukraine remain potential sources of investor cognitive dissonance. Miraculously (and perhaps ironically too), it
appears as though China is re-introducing ‘moral hazard’ into the investment
equation by allowing a corporation to go bankrupt (to date the Chinese central
bank has acted as a put to all institutional debt). So far, the Market have remained calm. But if China actually lets to policy continue
to its logical conclusion, then the global markets are staring at some rather unpleasant
losses. And that can’t be good for US stocks.
And:
Ukraine will
remain a hot spot as long as the West continues its self-righteous jabbering
about Russian aggression. In truth, it
is doing nothing more than the US did in Cuba---acting in its own self-interest
to insure its economic/political health.
As long as the US keeps harassing Russia, it runs the risk of Putin
escalating the crisis until we have to back down. My guess is that process will not 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, though the risks remain 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.
Update on the
Buffett valuation indicator (short):
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 16452 1878
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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