4/26/14
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 5055-17405
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1816-1993
Intermediate
Term Uptrend 1770-2570
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 economic data was mixed: positives---March durable goods orders, the
April Richmond Fed manufacturing index, April consumer sentiment and March
leading economic indicators; negatives---weekly mortgage and purchase
applications, March new home sales, the April Kansas City Fed manufacturing index
and weekly jobless claims; neutral---March existing home sales, weekly retail
sales, the March Chicago Fed National Activity Index, and the April Markit
Flash and service PMI’s.
The standout
numbers were weak housing offset by strong industrial activity. The tie goes to the positive side as
determined by the leading economic indicators.
At the risk of being repetitious, mixed data is to be expected in our
forecast. In that sense, it is good.
Our outlook
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 is awash in
cheap, clean burning natural gas.... In addition to making home heating more
affordable, low cost, abundant energy serves to draw those manufacturers back
to the US who are facing rising foreign labor costs and relying on energy
resources that carry negative political risks.
The
negatives:
(1) a
vulnerable global banking system. Bankamerica
got spanked this week for $13 billion for mortgage fraud
Barclays is
winding down some of its prop desk trading.
‘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. All
quiet among our ruling class this week except for yet another executive order---this
one on reviewing the sentences of drug offenders convicted prior to a recent
change in the law. To be clear, I happen
to agree with the purpose of this order.
However, it is a further usurpation of congressional authority [congress
was already working on its own fix]. One
day I believe that we will rue the imperial presidency [for those who aren’t already],
(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.
Our central
bankers were quiet this week save for the ECB stating that it may increase its
asset purchases if it doesn’t see a pickup in inflation. I have noted before that the ECB has been reasonably
firm in its monetary policy. So some ease wouldn’t be a bad thing for the EU
economy; although depending on how large the expansion and how the new liquidity
is put to work, it could exacerbate the problems created by the hugely
expansive policies of the US and Japan.
In the end, I continue
to believe that [a] at some point, electorates are going to rebel over policies
that only make their lives worse and [b] whether they do or not, history tells
us that when, as and if a transition begins {i} the Fed (central banks) will
bungle it and {ii} the longer it takes, the greater the pain.
(3)
a blow up in the Middle East or someplace else. The
situation in Ukraine just keeps getting worse, with open conflict now between
the government and the pro Russian rebels in the eastern provinces. Indeed, last night many of the major news
shows had experts on predicting a Russian invasion this weekend. I maintain my belief that whatever the
outcome, Putin will be happy.
The latest from
Ukraine:
My bottom line
has been that ‘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.
Well to His
credit, the US sent forces into Poland and the Baltic states this week on ‘maneuvers’. That said, this could have been a bit more
convincing. Only 600 US troops are being
deployed and not on a permanent basis---hardly a show of force. Nevertheless, it is a start and perhaps the
strategy is to escalate our presence should Russia ramp up its efforts in
Ukraine.
My concern
remains that Obama will misplay this hand and precipitate not only His own
public humiliation but also a spike in oil prices.
On another
front (medium):
(4)
finally, the sovereign and bank debt crisis in Europe and
around the globe. The economic data out
of China and Japan continues to be lousy.
Japan has responded by threatening to double down on its double down of
QEInfinity. I have absolutely nothing
positive to say about this bit of insanity.
Whatever the final outcome is from unwinding the global bout of monetary
expansion, this will only make it worse---and that says nothing about the
impact on the Japanese workingman.
The inflation rate
in the EU fell; and the ECB made it known that if it doesn’t pick up it intends
to begin asset purchases. Of course, it
has made this treat repeatedly and done nothing. The difference this time is that the Germans
are on board. To be fair, the ECB has been reasonably firm in its monetary
policy to date; so all things being equal, it has the room to be more
accommodative. That said, easy money
hasn’t worked for the US or Japan. So I am
not sure why the ECB expects a different outcome. In addition, I am not sure how it will help
the sovereigns to service their debt and the solvency of the banks that hold
it.
China, on the other
hand, has made it clear that it intends to let Market forces at least partially
control the economic end game. As you
might suspect, I believe this the preferable strategy, although it will no
doubt have some negative short term consequences---the most immediate of which
is the unwinding of the yuan ‘carry trade’.
Of course, as I continue to note, to date
the various government leaders have managed to keep their respective crises under
control. Clearly, they may be able to
continue to do so. However, this
narrative is not a prediction of disaster; it is an analysis of risks facing
the US economy and securities markets.
And the risk is one or more of these situations spins out of control.
Bottom line: the US economy continues to progress. While
the Fed continues its ‘taper’, it also continues to confuse the hell out of
investors as it lurches from one contradictory statement to another. I
continue to believe that (1) the Fed has no idea about how to extract itself
from a disastrous QEInfinity, (2) this means that it will once again bungle the
transition to tighter money and induce more pain in the Markets than they might
otherwise have had to suffer and (3) because QE has had so small an impact on
the economy, then the transition process will be manageable, economically
speaking---the pain being felt in the securities markets.
The Chinese government
continues its new policies [the government is not the answer, re-introducing
‘moral hazard’ into the investment equation] in spite of a flow of
disappointing economic data and the ongoing depreciation of the yuan. If it
sticks to its guns, then I believe that there is apt to be some discomfort
along the way, not just for the Chinese but for the rest of the globe. To its credit, it has managed the process
reasonably well to date---the operative words being ‘to date’.
The weak EU and
Japanese economies are also areas of concern.
This week, (1) the ECB promised easier money if inflation doesn’t pick
up. That is not necessarily bad; but
depending on how it is executed, it may not be good, (2) Japan seems intent on
going ahead with QEInfinity squared.
Given its total lack of effectiveness to date, I can’t see how this will
help or how this economic mess resolves itself without some real pain.
Finally, military
confrontation is now occurring in Ukraine.
While I have no idea what the final solution looks like, my best guess
is that in the end, Putin will be happy. I just hope he spares us Obama’s public
humiliation.
In sum, the US
economy is something about which to rejoice but is it facing a number
potentially troublesome headwinds.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
both down; March existing home sales fell less than anticipated; March new home
sales were terrible,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims rose more than forecast; April
consumer sentiment was better than estimates,
(3)
industry: March durable goods orders were strong; the
March Chicago Fed National Activity Index was in line with expectations; the
April Richmond Fed manufacturing index was stronger than estimates while the
Kansas City index was slightly weaker than anticipated; both the April Markit
Flash and service PMI’s were slightly less than consensus,
(4)
macroeconomic: March leading economic indicators were
slightly above forecast.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16361, S&P 1863) had another volatile week, (1) trending up
Monday through Thursday [it appeared that the Averages were consolidating the preceding
big eight day spike up via a sideways move] (2) but then they suffered some
severe whackage on Friday. While none of
their primary trends were broken, they ended the week near their 50 day moving averages. In addition, they are now forming a right
shoulder of a head and shoulders formation.
Now I recognized that many of these technical patterns have not gone
according to Hoyle in the last year; but I think it would be a mistake to
completely ignore them. So, this
developing head and shoulders is, at the least, something to watch.
The S&P
closed within uptrends across all timeframes: short (1816-1993), intermediate
(1770-2570) and long (739-1910). The Dow
remains within short (15330-16601) and intermediate (14696-16601) term trading
ranges and a long term uptrend (5055-17405).
They continue out of sync in their short and intermediate term trends.
Volume on Friday
was up; breadth deteriorated. The VIX rallied
but continues to offer no directional help with the Market. It finished within its short term trading
range, below its 50 day moving average and within an intermediate term
downtrend.
The long Treasury
resumed its upward march this week, closing within a short term uptrend and an
intermediate term downtrend and above its 50 day moving average.
GLD’s chart
remains a dog. It is within both short
and intermediate term downtrends and below its 50 day moving average.
Bottom line: Monday
though Thursday the indices weekly pin action was quite positive. I was especially impressed with the Wednesday/Thursday
consolidation process given the extent of their overbought condition. Then
Friday’s performance spoiled it all. Stocks
got smacked supposedly over tensions in Ukraine; but that is old news. The universe has known for weeks that Putin
was going to push the issue until he got what he wanted; and investors have
made a point of not caring. So this action may be nothing more than the finale
to the consolidation process.
The two bits of
bad news from Friday was (1) the indices neared their 50 day moving averages
and (2) it set the stage for building the right shoulder of a head and
shoulders formation.
Nonetheless, I remain
of the opinion that the Averages will assault the upper boundaries of their
long term uptrends but, due to the growing number of divergences, fail in that
challenge.
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.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (16361)
finished this week about 39.8% above Fair Value (11700) while the S&P (1864)
closed 28.3% overvalued (1452). 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, Japan and China.
The economy
continues to perform as described in our outlook---a low growth rate. Unfortunately that is the good news; and even
more unfortunate, it is more than adequately reflected in our Valuation Model. That leaves me in the peculiar position of
being upbeat on the economy but very concerned about current valuations. Especially so in the face of a bevy of risks that
could derail the unbelievable effort by US industry to recover from the
2008/2009 recession. They include:
(1) a
Fed that has gone out of its way to confuse investors while continuing to
implement its tapering policy. To be
clear, I am not worried about either the confusion or the tapering. Indeed, my hope is that the Fed sticks to its
current policy. However, that is only
because it is the less painful route to a normalized monetary policy. If
history is any guide then given the magnitude of reserves sitting on bank
balance sheets, the transition from easy money will likely be a very bumpy one
and not without a snoot full of hurt.
Nonetheless, I continue to maintain most of the agony will be in the
equities markets not the economy for the simple reason that the QE’s have had
more impact on the Markets than on the economy.
(2) problems
in the other major global economies.
[a] Japan seems
to have a death wish in attempting to set an intergalactic record for how long
it can balloon its money supply while simultaneously remaining stuck in a zero
growth economy. I have no idea how this country
extracts itself from the disaster its ruling class has created; but I suspect
there will be a bit of pain.
Unfortunately, that could have an impact on {i} our own growth and {ii}
the yen ‘carry trade’ which if unwound at a loss could destabilize securities prices
in the US market,
[b] the EU is
struggling to get out of recession. The
ECB has stated that it will take whatever measures necessary to avoid another downturn. While it has some leeway given its current monetary
austerity, it is not the economies of the EU that I worry about. It is the magnitude of the sovereign debts
and the overleverage of the banks that hold that debt. That leaves the ECB walking a tightrope
between faltering tax revenues that service the sovereign debt and higher
interest rates that would raise the cost of that service. A failure of either a sovereign to meet a
debt payment or a major bank would have negative implications for global
securities markets.
[c] China’s economy
is slowing while the Bank of China is attempting to rein in rampant speculation
in real estate and deal with the resulting mass of unproductive non-income
generating assets. To date, it seems to
be following a strategy of letting the markets clear the dead wood. While I believe that this is the right thing
to do, there is nothing pleasant about removing excesses. Like Japan and the EU, China is a major
trading partner of the US which means a potential economic impact from this
process. More importantly for the
Markets, there is, like Japan, a very large yuan ‘carry trade’ which appears to
be in the initial stages of being unwound.
And like Japan, that process could be extremely painful for US
investors.
[d] finally, Ukraine
isn’t going away. Indeed, it seems to be
getting worse every day. I am not so
much worried about Russia gaining control of eastern and southern Ukraine {easy
for me to say; I am not Ukrainian} or even some sort of armed US/Russia
confrontation {Obama doesn’t have the balls}.
I am concerned that {i} Obama will make a misstep and get humiliated on
the world stage, {ii} and as part of that, Putin takes steps that spike the
price of oil {iii} the whole Benghazi/Syria/Ukraine wimpy foreign policy will
leave the US vulnerable to more aggression from those who wish us harm. None of those will improve long term investor
psychology.
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.
Bottom line: the
assumptions in our Economic Model haven’t changed. 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.
Bear
in mind, this is not a recommendation to run for the hills. Our Portfolios are still 55-60% invested and
their cash position is a function of individual stocks either hitting their
Sell Half Prices or their underlying company failing to meet the requisite
minimum financial criteria needed for inclusion in our Universe.
It
is a cautionary note not to chase this rally.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 4/30/14 11700 1452
Close this week 16361 1863
Over Valuation vs. 4/30 Close
5% overvalued 12285 1524
10%
overvalued 12870 1597
15%
overvalued 13455
1669
20%
overvalued 14040 1742
25%
overvalued 14625 1815
30%
overvalued 15210 1887
35%
overvalued 15795 1960
40%
overvalued 16380 2032
45%overvalued 16965 2105
Under Valuation vs. 4/30 Close
5%
undervalued 11115 1379
10%undervalued 10530
1306
15%undervalued 9945 1234
* 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.
