The Closing Bell
5/3//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 1822-1999
Intermediate
Term Uptrend 1776-2576
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 49%
Aggressive
Growth Portfolio 46%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s economic data was generally upbeat (with one huge exception): positives---March
pending home sales, the February Case Shiller home price index, the April ADP
private payroll report, April nonfarm payrolls, March personal income and
spending, April Chicago PMI and the April Dallas Fed manufacturing index;
negatives---weekly mortgage and purchase applications, March construction
spending, March factory orders, weekly jobless claims and the initial first
quarter GDP report; neutral---weekly retail sales, April ISM manufacturing index, the April Markit PMI and
April US vehicle sales.
The aforementioned
exception, of course, was the very disappointing first quarter GDP report. However, the punditry is allowing that (1)
there will be two revisions before the final reading and so the number will
almost surely be revised up, (2) the data late in the first quarter showed definite
improvement and (3) the old standby---weather.
Not that this isn’t the case. As you know, I recently turned off the
flashing warning light on the economy; so I can hardly argue with the
conclusion.
On Friday’s jobs
report (medium):
Update on big
four economic indicators (medium):
That said, the
bond market performance (rates down in front of better anticipated economic
data and Fed tapering) is worrisome and calls into question the preferred
forecast. So I simply ask the same
question as I am doing with every other risk that the economy/Market
faces---what are the odds that consensus (which includes moi) on the economy is
wrong.
Nevertheless, 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
The
negatives:
(1) a
vulnerable global banking system. This
week’s most stunning news with respect to our banksters collectively continuing
to prove that they are unworthy of our confidence is Bankamerica suddenly
having to revise its recent positive financial report (medium):
And this: Deutsche bank’s
derivative exposure (medium):
However, regulators
may at long last be getting serious about justice, though they apparently fear
that prosecuting these thieves may spark a financial crisis---sort of like, you
know, putting Willy Sutton in jail would cause a bank run (medium and a must
read):
‘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 the GOP leadership trying to
see just how liberal a stance they can take on immigration and not switch
parties. If this is some new trend, then
any hope there is that the ruling class will come to its senses and do the
right thing is near death---not something that will prompt me to up the
potential growth rate of 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.
As you know,
the FOMC met this week. The results were
generally expected---their economic forecast was slightly more upbeat [the first
quarter GDP number notwithstanding] and tapering is proceeding with another $10
billion reduction in monthly bond/mortgage purchases. That makes sense to me. The economy is improving, though probably not
as much as they believe, and I applaud the tapering. Further, investors seem happy.
That said, I am
still concerned about (1) the Fed’s ability to see the transition through to a
successful completion---which, as I too often point out, they have never done
in the past and (2) as I noted above, bond investors don’t seem to be buying
this goldilocks scenario. If the economy
is improving and money is tightening, then higher interest rates would be a
natural outcome. But rates are dropping
which to me means that either the Fed’s [and perhaps our] outlook is too
optimistic or stock investors should be more worried about some negative event
out of Ukraine/China/Japan.
http://www.zerohedge.com/news/2014-05-01/weaning-stock-market-casino-capitalism-will-be-anything-pain-free
(must read)
(3)
a blow up in the Middle East or someplace else. The
situation in Ukraine just keeps getting worse.
Bullets are flying and at last count 40 pro Russian separatists are dead. I still don’t have a clue how this ends
except that I am sure that Putin will be happy. My concerns are the end game will
include [a] the potential for Obama’s public humiliation and [b] higher oil
prices.
The latest from
Ukraine:
(4)
finally, the sovereign and bank debt crisis in Europe and
around the globe. The economic data out
of China, the EU and Japan continues to be poor. Japan’s response will
apparently be to double down on its QE policy.
Given its complete and total lack of success in the past, I have no clue
why. I do believe that it will not be
positive for Japanese industry or consumers.
Given that [a] the Japan is a major US trading partner and [b] the
exposure of US financial institutions to the yen ‘carry trade’, it potentially
may also not be so good for the US.
Deflation is
the risk in the EU; and the ECB has stated publicly that it wants to ease
monetary policy. Given the ECB’s past
policy of austerity, it does have flexibility in this approach to policy. However, there have been behind the scenes
murmurings [which I have linked to] that its official desire to ease may not accurately
reflect policymakers true intentions. In
any case, my concerns are less about EU economic growth and more about [a] the
ability of their heavily indebted
sovereigns to service their debt and [b] the solvency of its heavily leveraged
banks that own most of that debt, in any economically stressful scenario.
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. The Fed is
maintaining its ‘tapering’ policy---which is a plus, in the sense that it’s
better late than never. Until it proves
otherwise, I am sticking to the thesis that [a] the Fed has never transitioned
from easy to tight money without bungling the process, [b] given the extremes
to which QEInfinity went, the consequences will also likely be extreme, [c] it will
induce more pain in the Markets than the economy because QE has had so small an
impact on the economy.
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 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 of potentially
troublesome headwinds.
This week’s
data:
(1)
housing: March construction spending was disappointing;
weekly mortgage and purchase applications were both down; March pending home
sales rose more than anticipated; the February Case Shiller home price index
was up slightly more than expected,
(2)
consumer: weekly
retail sales were mixed; April US vehicle sales were in line; weekly jobless
claims rose more than forecast; April consumer confidence was slightly less
than estimates; weekly jobless claims were lousy; the April ADP private payroll
report showed better job growth than consensus; April nonfarm payrolls were a
blowout; both March personal income and spending were better than anticipated,
(3)
industry: the April Chicago PMI was well above
expectations; the April Dallas Fed manufacturing index was stronger than
estimates, the April ISM manufacturing index was in line as was the April
Markit PMI; March factory orders were below consensus,
(4)
macroeconomic: the initial first quarter GDP report was
dramatically less than forecast.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16512, S&P 1881) were up this week, though they ended the
week amid something of a pause. In itself,
that is not bad, especially after the recent run up. However, they did have a problem with some obvious
resistance levels---including the developing head and shoulders formation in
the S&P and the second unsuccessful attempt by the Dow to get above its all-time
high.
The S&P
closed within uptrends across all timeframes: short (1822-1949), intermediate
(1776-2576) 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 flat; breadth deteriorated. The VIX fell
and is nearing the lower boundary of its short term trading range. Of course, this is the eleventh time it has
done this in the last year and a half; so I am not sure it will be any more
meaningful this time than the others. It also finished below its 50 day moving
average and within an intermediate term downtrend.
The long Treasury
(112.7) remains on a sizz. It is in a short
term uptrend, above its 50 day moving average and approaching the upper boundary
(113.7) of its intermediate term downtrend.
If it were to penetrate 113.7, the next resistance points are at 120.6
and 125.8. As you know from prior notes,
this performance has been a head scratcher for me.
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: this
week’s pause in the Averages upward march was to be expected. What bothers me is the aforementioned incongruous
behavior of the bond Market and the implications is might have for stocks. By that I mean, the bonds markets have
historically been better at anticipating circumstances that could lead to a change
in valuation metrics. At this moment,
lower bond prices are not reflective of an improving economy especially one
that would prompt the Fed to accelerate the transition to tighter money. I have no clue where this goes; I am simply
raising the prospects that there may be changes afoot.
In the absence of
any exogenous events, I am sticking with 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 (16512)
finished this week about 40.8% above Fair Value (11725) while the S&P (1881)
closed 29.2% 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 this week was positive and fits nicely into our Economic Model. Unfortunately, it doesn’t support current
equity prices 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.
The Fed remains
a liability to our economy. Its
extraordinary monetary experiment is nearing its end game which I believe will conclude
badly for the Markets (1) because these transitions have always ended badly and
(2) stocks have been the prime beneficiary of QEInfinity; so it seems logical
that they will be the most damaged as it terminates. I am frankly a bit surprised by investors’
recent nonchalant attitude towards tapering.
True, Markets haven’t crashed; they also have gone nowhere. But we are just the beginning of the
transition.
Japan continues
to pursue its ‘Zimbabwe’ strategy which seems destined to become a case study
at Harvard about how not to run monetary policy. Its version of QEInfinity is already
destroying the Japanese working class (sound familiar?) and the fat lady hasn’t
even sung yet. And when she does, I
worry about the effect on [a] our own growth and [b] the yen ‘carry trade’
which if unwound at a loss 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, there may be reason to believe that it will maintain
a more austere agenda. As you know, I am
less worried about the economic impact of a recession on the US and more
worried 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.
Not much news
out of China this week; though there is no reason to believe that it has
altered its strategy of re-injecting moral hazard into its financial
system. I have made it clear that I
think this the least painful way to reversing a profligate fiscal policy and
far too easy monetary policy---‘least’ being the operative word. If the government sticks to its guns there
will likely be an economic impact on the US from this major trading
partner. However, I am more concerned
about the affect it will have on our financial markets as the yuan ‘carry’
trade is unwound.
Despite some half
assed attempts at negotiations, Ukraine is sinking into a military conflict. 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 [a] Obama
will make a misstep and get humiliated on the world stage, [b] as part of that,
Putin takes steps that spike the price of oil and [c] the whole Benghazi/Syria/Libya/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.
Finally, I am
confused/concerned about the recent pin action in the bond market. By that I mean that if the Fed’s economic
forecast is correct (and investors seem to have unbridled faith in these guys
[gal]) and if it continues to taper, most individuals would expect a rise in
interest rates. That ain’t happenin’. Why? [a] noise, [b] the economy is weaker
than believed, [c] major negative international event, [d] all of the above,
[e] you guess. In other words, I don’t
know. But I do believe that bonds could
be signaling a development totally unexpected by the stock boys and, therefore,
is yet another risk about which to worry.
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.
The latest from
Jeremy Grantham (medium):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 5/31/14 11725 1455
Close this week 16512 1881
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.
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