The Closing Bell
5/31/14
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 Uptrend 16021-17500
Intermediate Uptrend 16143-20500
Long Term Uptrend 5081-18193
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1855-2022
Intermediate
Term Uptrend 1803-2603
Long Term Uptrend 748-1960
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 51%
Aggressive
Growth Portfolio 46%
Economics/Politics
The
economy is a modest positive for Your Money. The
data weighed to the negative side this week: positives---the March Case Shiller
home price index, weekly jobless claims, April durable goods orders, May
Chicago PMI, the May Markit flash services PMI and first quarter corporate
profits; negatives---weekly mortgage and purchase applications, April pending
home sales, May personal income and spending, May consumer sentiment, the
Richmond and Dallas manufacturing indices and first quarter GDP; neutral---weekly
retail sales and May consumer confidence.
The standout
datapoints were: (1) solid April durable goods orders; that number along with a
host of supporting stats portrayed an industrial sector still chugging along,
(2) revised first quarter GDP---although the universe is dismissing this figure
as irrelevant and (3) April personal income and spending---both of which were
disappointing, both of which question the irrelevance of the aforementioned GDP
data.
I recognize that
questioning the strength of the economy would put me three standard deviations
from consensus; but consider:
(1)
unanimity among the pundits that the first quarter GDP reading was totally a function
of weather. Aren’t January and February
always cold and stormy? If so, why aren’t
all first quarter GDP numbers down?
(2) April isn’t
winter [re; personal income and spending],
(3) the bond
market is suggesting economic weakness and the gold market is screaming
economic weakness,
(4) the Japanese
economy is sliding deeper into recession if it not already there,
(5) China’s real
estate market is crashing; it is doing so with the implicit consent of the
government, so there is likely no fiscal or monetary bailout coming,
(6) Europe is
slipping into recession. The world
believes that some form of QE is coming in June, but [a] what if it is as limp
wristed as prior initiatives, [b] what if it works as well as it has in the US
and Japan---which is to say, not at all, [c] it does nothing to address the EU
real problems which are overly indebted sovereigns and overleveraged banks.
I am not
building a case for a US recession. I am
pointing out that there are stats (and not insignificant ones at that) that are
suggesting one and a host of other potential problems which, if they worsened,
would contribute to a recession. The
proof of the pudding is that I am not altering our forecast; however, I believe
it would be the height of folly to ignore the current data. Accordingly, I leave the outlook in tact but
re-start the flashing yellow light:
‘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. It was
a slow week for bankster malfeasance.
Although our
Justice Department is going after a bank---just not an American one:
‘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. Election
season is approaching so much of the activity of our ruling class is
unsurprisingly focused on self-preservation and scoring political points
[abundant hearing on the VA scandal, the GOP doing its best to further fuck up
our immigration policy and volumes of righteous indignation over Ukraine] versus
doing anything to help the unwashed masses.
(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.
Over the past
two weeks, the Fed has made it clear that it is totally unclear about how it
will extricate itself from QEInfinity. In a series of speeches from regional
Fed chiefs, every possible alternative has been advocated but no course has
been defined. This uncertainty wouldn’t
be quite so bad if not for the fact that [a] Fed policy is in totally uncharted
territory and [b] the Fed has never successfully transitioned from easy to
tight money even when its monetary expansion had been just run of the mill.
I continue to
believe that QEInfinity will not end well and that the price will be paid
primarily by the Markets.
(3)
a blow up in the Middle East or someplace else. Ukraine
isn’t going away until Putin gets what he wants. Since the last note, Ukraine held a
presidential vote and elected a pro-western businessman. Unfortunately, the only result has been an
increase in violence.
Given our pathetic
diplomatic response to this situation, it is probably a waste of time to stew
over the longer term geopolitical implications---negative though they may
be. So my concerns are shorter term: [a]
impact on oil prices---the current Ukrainian gas contracts expire in June. What will Russian do? [b] Obama misjudges
Putin and takes a hard right to the groin.
(4)
finally, the sovereign and bank debt crisis in Europe and
around the globe. Despite pursuing a ‘QEInfinity
on steroids’ monetary policy, the Japanese economy continues to sink of its own
weight, demonstrating, in my opinion, beyond a reasonable doubt that monetary
policy is the problem not the solution.
And yet, on it goes; and where it stops, nobody knows. But the likelihood that it will be a plus for
the Japanese economy or securities markets is not zero.
China’s real
estate market is imploding. This week, I
linked to an interview with that country’s largest real estate developer---who wasn’t
exactly upbeat. So far the government has managed to contain the fallout. Given the size of the real estate market
relative to the whole economy, the risk remains that it will not.
The EU economy
is close to slipping into deflation.
Draghi has sworn that he will take all steps necessary to bail out the
economy; but to date, he has been all talk and no do. Last weekend, the EU voted in parliamentary
elections and the overall result was a rejection of the status quo. In other words, current policies aren’t
working, so try something new. As fate
would have it, the ECB will meet in June and apparently that ‘something new’ is
going to be QE---not fiscal or banking reform which is what is needed; but then
that would disturb the fat lives of the eurocrats and banksters. Quite unbelievably, in my opinion, the world
seems to think that it will actually work---the US and Japanese failures
notwithstanding.
I am flummoxed by
the economic and securities communities’ willingness to accept at face value
that QE has, is and will work anywhere, anytime. To be sure, nothing untoward has occurred yet. But then no one except the Chinese has
started the unwinding process and the last chapter has not been written the
Chinese real estate implosion. This
remains a big risk to our forecast.
Bottom line: the US economy continues to progress. However,
Fed policy (or perhaps a lack thereof) remains a risk in that the unwinding of
QEInfinity could result in economic, or more likely, unanticipated Market
disruptions. I am not saying that this
is a foregone conclusion; I am saying that history suggests that the odds of this
risk materializing is well above zero.
‘Likewise, unconventional monetary policy is
causing problems around the globe: [a] Japan seems intent on seeing how close
its monetary policy can come to Zimbabwe’s without destroying the economy, [b]
the Chinese actually appear to be doing everything possible to wind down its
expansive monetary and fiscal policies.
That will pay dividends in the long run; but short term it could cause
some heartburn both at home and abroad, [c] the European ruling class is doing
everything it can to impose its dream of a transnational government on a bunch
of sovereigns that spend the bulk of their time trying to ‘game’ the new
ideal. It may work; but so far it
hasn’t. And if it doesn’t, there are
some awfully indebted sovereigns and leveraged national banks that could take
it in the snoot---none of which will be good for the EU economy or its banking
system.’
Finally, military
confrontation continues in Ukraine, despite some mewings from Putin undoubtedly
designed to make incompetent western diplomats feel all warm and fuzzy. 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 and leaves the price of oil alone.
In sum, the US
economy is something about which to rejoice but is it facing a number of potentially
troublesome headwinds.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
both down; the March Case Shiller home price index rose; April pending home
sales were below expectations,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims were better than estimates; April
personal income increased less than forecast and personal spending was down; May
consumer confidence was in line, while consumer sentiment was below consensus,
(3)
industry: the April durable goods orders were strong; ditto
the May Markit flash services PMI; ditto the May Chicago PMI; both the Richmond
and Dallas Fed manufacturing indices were disappointing,
(4)
macroeconomic: first quarter GDP was down more than
anticipated but first quarter corporate profits rose.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16717, S&P 1923) had a great week. Both broke above recent highs and remain above
their 50 day moving averages. The Dow fulfilled
the time element of our discipline, remaining above the upper boundaries of its
short and intermediate term trading ranges through Thursday/Friday thereby (1) re-setting
both to uptrends: short [16021-17500]; intermediate [16143-20500] and (2)
putting it back in sync with the S&P.
Their join the long term uptrend: 5081-18193.
The S&P closed within uptrends cross all timeframes: short (1855-2022),
intermediate (1803-2603) and long (748-1960).
Volume on Friday
was up, largely as a function of rebalancing of the S&P; breadth was not
good, except for the flow of funds indicator which has been strong of late. The VIX fell, finishing within its short and
intermediate term downtrends and below its 50 day moving average. This measure of complacency should be a plus
for stocks near term. In the meantime, internal
divergences within the Market persist.
If they can’t be reversed, they should act as a governor on upward
momentum.
The long Treasury
also had a good week, breaking above the upper boundary of its intermediate term
downtrend and then confirming it. That
leaves it within very short term and short term uptrends and within an intermediate
term trading range. It is also above its
50 day moving average.
GLD’s chart is
as ugly as ever. It is within both short
and intermediate term downtrends and below its 50 day moving average.
Bottom line: the
Averages moved up and out of their very recent trading ranges. Both are now in uptrends across all
timeframes. That would be very positive were
it not for almost nonexistent volume and a multitude of nonconfirming technical
measures. That is not to say that those
indicators won’t catch up to the indices just as the Dow did with the S&P this
week. It is simply a word of caution to
not get overly aggressive if you just have to buy something and to be sure to set
tight trading stops.
My assumption
remains 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.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (16717)
finished this week about 42.5% above Fair Value (11725) while the S&P (1923)
closed 32.1% overvalued (1455). 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 economic
data flow in general remains upbeat and supportive of our economic forecast---though
I think it a bit too naïve to totally ignore that down 1% GDP number and April
personal income and spending. That said,
I am not sure that any of this matters to investors since, at the moment, all
news is excellent news. Unfortunately, our Valuation Model has this good news very
generously priced into stocks; and that ignores a plethora of potential
problems that could negatively impact the economy or the securities markets or
both. To be sure, nothing disastrous has
occurred to date. The risk is what could
happen tomorrow.
The Fed is at
the top of the list of those headwinds. It
has driven bank reserves to historically unprecedented levels and now appears
to be grappling with how to undo its mischief.
Unfortunately, a huge part of this whole experiment (QEI admittedly stabilized
our financial system) accomplished nothing.
Indeed, it may have done great harm in that it screwed the savings
class, enriched the banksters and likely pulled forward demand that will
eventually push the economy into recession.
I maintain my belief that the Fed will botch the return to a normal
monetary policy and that the Markets will pay dearly for the Fed’s mistake.
Of course, the
Fed isn’t the only central bank capable of mischief. Japan is the paragon of fiscal and monetary irresponsibility
and it is starting to pay the price.
This week’s data showed conditions exactly the opposite of what these
masters of the universe intended---slowing growth and rising inflation. A recession there would impact our own growth;
and increasing inflation/interest rates would likely lead to an unwind of the
yen ‘carry trade’ which could destabilize securities prices in the US market.
The EU continues
struggling to get out of recession/deflation.
While the ECB has stated that it will take whatever measures necessary
to avoid another downturn, that is all that it has done---all talk and no
do. Expectations are for some sort of QE
to come out of the ECB June meeting. It
could happen. Regrettably, it would do
nothing to address the EU main problems. My concern here is about a disruption
in our financial system resulting from either a default of one of the EU’s many
heavily indebted sovereigns or the bankruptcy of one of its many overleveraged
banks.
The Chinese are
trying to do the right thing by wringing speculation out of its financial
system. To date it has done an admirable
job preventing this problem from infecting the international markets. I worry that it will not be so lucky/skillful
going forward.
Ukraine is something
of a wild card. I have little doubt that
Putin will get what he wants when all is said and done. Aside from this spectacle being yet another
foreign policy humiliation for the US, my more immediate concern is the control
Putin exercises over the price of energy in Europe. Oil/gas prices, of course, don’t have to
rise; but the political/military costs for that not happening may be prove even
more unbearable in the long run.
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 (though this week’s data
supported by the bond market could be signaling that they are about to). 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 5/31/14 11725 1455
Close this week 16717 1923
Over Valuation vs. 5/31 Close
5% overvalued 12311 1527
10%
overvalued 12897 1600
15%
overvalued 13483 1673
20%
overvalued 14070 1746
25%
overvalued 14656 1818
30%
overvalued 15242 1891
35%
overvalued 15828 1964
40%
overvalued 16415 2037
45%overvalued 17001 2109
Under Valuation vs. 5/31 Close
5%
undervalued 11138 1382
10%undervalued 10552
1309
15%undervalued 9966 1236
* 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.
