The Closing Bell
4/12//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 1802-1979
Intermediate
Term Uptrend 1752-2552
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. There
was a dearth of stats this week though most of what we got was positive: positives---weekly
purchase applications, weekly retail sales, weekly jobless claims, March small
business optimism, initial April consumer sentiment; negatives---weekly
mortgage applications and March PPI for final demand; neutral---none.
While the
preponderance of data was upbeat, I would hardly qualify this week’s sparse numbers
as a strong endorsement of our forecast.
On the other hand, they were better than a sharp stick in the eye. However, given the overall lack of stats this
week, I am leaving the yellow light flashing for one more week.
The real news (I
think) was the dovish tone of the latest FOMC minutes. Investors certainly loved it (at least for a
day); but as I noted in Thursday’s Morning Call, I was bit puzzled by the
euphoric reaction because ‘this
supposedly clarifying discussion took place before the ensuing string of
perplexingly contradictory statements from various Fed members.’ Hence, I think it a bit early to assume that
QEInfinity is back on the table. That
said, whether it is or not won’t really impact our forecast since it
incorporates ‘the historic inability of the Fed to properly time the reversal
of a vastly over expansive monetary policy’.
‘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. We
actually got some good news this week. To be sure, the ongoing stream of
multimillion dollar settlements for bankster mischief continues---the latest
being from Citigroup and Bankamerica.
Plus a new
plague is upon us: covenant lite loans (medium, read it and weep):
In addition, a
former lawyer from the SEC blasted his old agency for its bias toward the large
banks---I linked to an article on this subject in Wednesday’s Morning Call.
Now to the good
news; all of which address the issue of bank management taking inappropriate
risk in an attempt to earn big bonus knowing that the US taxpayer is there to
bail them out:
[a] government
regulators increase capital requirements of large banks (must read),
[b] Goldman is
exiting high frequency trading and dark pools [link in Wednesday’s Morning
Call].
[c] new rules
require more capital for derivatives trading (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. The electioneering continues with Obama [unconstitutionally]
using executive power to circumvent congressional authority by issuing
regulations that supposedly address the minimum wage and equal pay among the sexes. Much of the commentary that I have seen is
that both measures are much ado about nothing. But they illustrate a point that I have been dwelling
on of late---our political elite’s primary focus is on electioneering versus doing
anything to help the economy.
There is some good news; but remember at
least a part of this is a function of very low interest rate payments on our
gargantuan debt (medium):
(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.
Fed policy got
a bit more confusing this week [again] as investors interpreted the minutes of
the last FOMC meeting as being very dovish [at least for a day]. I covered this both above and in Thursday’s
Morning Call; so I there is really nothing to add---save the conclusion: in my
opinion, the longer the Fed waits to begin the transition to tighter money the
greater the odds of it bungling that process and the greater the pain to be
endured in the process.
(4)
a blow up in the Middle East or someplace else. The diplomatic turmoil over Ukraine’s future
continued to heat up this week as both sides accused the other of sending in
agents to foment trouble. I am not
foreign policy expert so I have no idea how this plays out; although I would
bet money that whatever the outcome, Putin will be happy.
My bottom line:
‘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.’
(5)
finally, the sovereign and bank debt crisis in Europe and
around the globe. In the EU, Draghi made
another one of his ‘whatever it takes’ speeches though it is still very much in
question whether he had the authority or the resources to actually deliver on
such a promise. Pardon my skepticism,
but until I see some action, I take his comments with a grain of salt.
David Stockman
on the Greek bond sale (medium):
Meanwhile, the
Chinese economic data worsens, two more companies defaulted on bond issues
[though to date, one has been bailed out by a guarantor] and the government
stated quite explicitly on Thursday that no new stimulus measures were
forthcoming.
Japanese stats
are also getting worse. Unlike China, Abe
is promising QEInfinity squared.
Please. How is doubling down on a
policy that hasn’t worked going to improve conditions; I am reminded of
Einstein’s definition of insanity.
All that said, I
have to acknowledge that 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, disastrous
Fed and fiscal policy notwithstanding.
I don’t even
know where to start in assessing the damage our political class has, is and
will probably continue impose on the economy.
Nefarious executive proclamations, incomprehensively incompetent and
dangerous foreign policy, anti-free market and politically motivated regulatory
policy (the new banking regulations being an outstanding exception) and
ignorance and/or inattention to needed economic growth policies act as an
enormous burden. That business has
managed to keep the economy moving forward is a fucking miracle.
Fed policy remains
somewhat confusing despite the dovish tone of the minutes from the latest FOMC
meeting. The Market went on a one day
party binge apparently on the assumption that those minutes were the Holy Grail
of monetary policy; but then awoke, took two aspirins, remembered all the subsequent
contradictory comments and realized once again that the Fed doesn’t have a clue
how to extract itself from its ill-conceived QEInfinity. I continue to believe that (1) this weakness
a sign 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 (2) 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 of (1) the government is not the answer and (2) re-introducing
‘moral hazard’ into the investment equation.
Why I would even consider cheering the policies of a communist
government rather than my own is ironic but sad. That said, if it sticks to its guns, then
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 reasonable well to date---the operative
words being ‘to date’.
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. Japan seems poised to double down
on its own version of QEInfinity---again reminding me of Einstein’s definition
of insanity.
Finally, the probability
of a flare up Ukraine appears to be rising and with it, the likelihood of
upward pressure on oil prices---which would not be helpful for a global economy
struggling to not flatline. This says
nothing of the potential psychologically negative impact on the US electorate
(investor) of Putin humiliating Obama publicly.
In sum, a resilient
US economy is something about which to rejoice but is it facing a number
potentially troublesome headwinds. Thus
far, they have been contained. So I
leave my ‘muddling through’ scenario in place with the warning light flashing
at an ever closer shade of red.
This week’s
data:
(1)
housing: weekly mortgage applications declined while
purchase applications rose,
(2)
consumer: weekly
retail sales advanced; weekly jobless claims fell and initial April consumer
sentiment was above forecast,
(3)
industry: March small business optimism rose,
(4)
macroeconomic: March PPI for final demand came in much
hotter than expected.
The Market-Disciplined Investing
Technical
` The
indices (DJIA 16029, S&P 1815) had another volatile week, most of it to the
downside. None of their primary trends
were broken, although both broke below their 50 day moving averages.
The S&P
closed within uptrends across all timeframes: short (1802-1979), intermediate
(1752-2552) 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;
though clearly the S&P is very close to the lower boundary of its short
term uptrend. In short, the Market is trendless.
Volume on Friday
was flat; breadth was mixed (a bit surprising).
It is a likely signal that stocks are way oversold---suggesting a bounce
back early next week. The VIX rose strongly again though it continues to offer
no directional help with the Market. It
finished within its short term trading range and intermediate term downtrend
and above its 50 day moving average.
The long Treasury
busted through the upper boundary of its short term trading range this week and
that break was confirmed. As a result,
the short term trading range re-sets to a short term uptrend (the former very
short term uptrend). It remains above
its 50 day moving average but within an intermediate term downtrend. This is a somewhat ominous sign since lower
rates typically mean with a recession/deflation or some sort of international turmoil
(think Ukraine).
GLD’s chart
remains a dog. It is within both short
and intermediate term downtrends but managed to close ever so slightly above
its 50 day moving average.
Bottom line: it was one of the roughest week in the Market
since February. Both of the Averages are
near levels where bounces have usually occurred in this uptrend. So if recent history repeats itself, then next
week’s pin action will repeat the ‘buy the dip’ pattern; and if that happens,
my assumption remains that the indices will still challenge the upper boundaries
of their long term uptrends.
Of course, at
some point in time that model will cease to work and a new prototype will
emerge. Certainly, with the current
magnitude of stock overvaluation and the multiple sources of potential risk (Japanese
economy, EU economy, Chinese financial markets, Ukraine, Fed policy), there is
a reasonable argument for a change in paradigm. That may or may not be the case this time; but
it is something to be paying attention to.
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.
The
Smart Money Flow Index (short):
Three reasons for a price
decline (medium):
Fundamental-A Dividend Growth Investment Strategy
The DJIA (16029)
finished this week about 37.0% above Fair Value (11700) while the S&P (1815)
closed 25.0% 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 and China.
While sparse, this
week’s economic stats upheld our forecast.
Indeed, if the volume of the dataflow had been normal, I would have
jerked the plug on flashing economic yellow light. Despite being a holiday shortened, next week
will provide some key datapoints. If all
goes well, I will turn off the alert.
That said, 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.
Fed induced
confusion over monetary policy was exacerbated this week. The dovish FOMC minutes gave investors a
brief euphoric kick but was over almost before it began. That leaves us where we were
before---puzzling over whether the Fed really has a handle on extracting itself
from its ginormous policy experiment.
Unless something changes, I suspect it means a higher probability of a
botched transition and, hence, more pain.
However, I continue to believe that the pain will be felt less in the economy
and more in the Markets for the simple reason that the QE’s have had more impact
on the Markets than on the economy.
The biggest
risks to the Market, in my opinion, come from potential negative events
overseas. China heads the list as its
economy slows, bankruptcies are increasing, its financial markets are going
through a massive deleveraging, the yuan carry trade is being unwound and the government
insists that it will allow the markets to take their own course. Japan and to a lesser extent the EU are
having problems getting any economic growth; and worse, so far the only
remedies the ruling classes are considering is doubling down on policies that already
haven’t worked. To be fair, the
politicians have thus far managed to maintain control of their difficulties;
and they may very well continue to do so until their respective economies are
out of trouble. The risk is that they
won’t.
Ukraine isn’t going
away; I suspect because Putin doesn’t want it to go away. It seems a foregone conclusion to me that
this situation will end as Putin wants it to.
Figuring out what form that will take is above my pay grade, but I seriously
doubt that he is concerned about any fallout from the US. My real concern is that the US get humiliated
in the process because I don’t think that will 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.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 4/30/14 11700 1452
Close this week 16029 1815
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.
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