The Closing Bell
5/10//14
Next week starts a busy month for me.
On Wednesday, we leave for a nephew’s wedding; so no Morning Calls
Thursday and Friday and no Closing Bell.
The following week, I have cataract surgery on my first eye on Thursday
morning. No Friday Morning Call and no
Closing Bell. Next week is normal. The
following week, I have cataract surgery on my other eye on Thursday morning. No Friday Morning Call, no Closing Bell. The next week, we attend our number one
grandson’s graduation. No Thursday or
Friday Morning Call, no Closing Bell. We
are back for a week. The next week, we
take our annual anniversary beach trip.
Nothing all week.
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 1828-1995
Intermediate
Term Uptrend 1780-2580
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 51%
Aggressive
Growth Portfolio 46%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s economic data was generally upbeat, though what we got was mostly
secondary indicators: positives---weekly mortgage and purchase applications,
weekly retail sales, April wholesale inventories and sales and the April ISM
nonmanufacturing index; negatives---first quarter productivity and unit labor
costs; neutral---the April Markit PMI services index and the March trade
deficit.
The most notable
aspect of this week’s data flow was the absence thereof; so there was nothing
to move the needle on our forecast.
There was testimony by Yellen before congress. We learned very little new except that (1) she
would not allow herself to get pinned down [as she did in her first round of
testimony] on the six months’ time frame for the start of a rise in interest
rates and (2) apparently tapering is not tightening [more on that later].
The strong bond
market performance (rates down in front of better anticipated economic data and
Fed tapering) took a pause this week, though it remains worrisome in that it
calls into question the preferred forecast.
We received a raft of theories for this phenomena this week (which I
linked to). Unfortunately, there was
little consensus. In addition, the
aforementioned pause raises the question as to whether this was just a giant
burst of noise. Nonetheless, I think we
must remain mindful that the recent incongruous lift in bond prices could be
signaling a potential adverse development for the economy
(recession/deflation). In the absence of
any clarity, 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 highlights of bankster misdeeds included;
[a] Credit Suisse’s potential $1 billion
settlement for assisting US citizens in tax avoidance,
[b] the revelation
that the banks are back making highly leveraged loans against questionable
credit {I linked to this article in Wednesday’s Morning Call. That link is below for those who didn’t read
it the first time}:
[c] the addition
of private equity firms to the scam artists’ Hall of Fame (medium):
This is today’s
absolutely must read article: an interview with Tim Geithner on the financial
crisis:
‘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. Our
ruling class remains silent save for threats to Russia and the slow progression
on the Benghazi investigation. Given
their extraordinarily low ratings in the polls, I can understand the low
profile. Unfortunately, as we move into
summer and the elections draw near, the electorate will be subjected to nonstop
scata from this crowd---which will undoubtedly amuse but do little to improve
the budget, tax or regulatory environment.
(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.
Yellen
testified before congress this week. She
predicted that the economy would strengthen but was still sufficiently weak
that a continued easy monetary policy was necessary. In other words, a perfect scenario. Somewhat confusing to me, ‘having said that the Fed would remain easy,
no one asked [a] isn’t tapering tightening? [b] if not, why not end it
completely today? [c] isn’t being easy destroying the savings class? and [d]
hasn’t being easy distorted price discovery within all asset classes? The point here is that the Fed can say
anything and no one challenges it.
Investors just want to have fun.’
This sort of
mindless happy talk [we are easing but tapering; don’t worry, be happy] only makes me more
cynical about what the ‘real’ Fed policy is and increases my concern about the
Fed’s ability to manage the transition to tighter money---which, as I too often
point out, they have never done in the past.
In addition, bond investors don’t seem to be buying this goldilocks
scenario. I don’t know how the latter
works out, but I regard it as a warning that the economy may not be on the
happy jack course many investors seem to accept unconditionally.
Great article from David
Stockman (a bit long but today’s must read):
Another great article on why QE
never worked (medium):
(3)
a blow up in the Middle East or someplace else. Ukraine
is still with us but in a more dangerous form; although the Markets don’t seem
too worried. This week’s main headline
was Putin jerking the rest of the world off by [a] saying that he was moving
troops away from the Ukrainian border {liar, liar, pants on fire} and [b] suggesting
that the eastern Ukrainians postpone an independence vote and then showing up in
Crimea for a victory lap.
I previously
noted that if the only issue was whose flag was flying over eastern Ukraine, I
could be a bit more relaxed. The problem
is how we get there which we almost surely will; and will that involve higher
oil prices or Obama getting drop kicked through the diplomatic goalposts.
(4)
finally, the sovereign and bank debt crisis in Europe and
around the globe. It was just as slow
week for international economic news flow as it was for us. Japan is still battling a shrinking economy
but with a depreciating yen; China’s real estate market continues to implode
and the EU is struggling to avoid economic stall speed.
Policy makers
are making matters worse: [a] Japan insists on pursuing a decade long failed QE
policy and [b] the ECB is considering its own version of QE which will only
exacerbate its real problem---overly indebted sovereigns and over leveraged
banks. To their credit, the Chinese are taking deliberate steps to curtail
rampant speculation; but in the short term that can be painful especially if it
results in the unwinding of the yuan carry trade.
The risks for
the US is [a] economic stagnation in Japan and its effect on the volume of
trade with the US along with the negative consequences on US financial
institutions of a unwinding of the yen carry trade, [b] economic stagnation in
the EU and its impact on the volume of trade with the US as well as the
counterparty risks associated with derivatives of EU sovereign debt and [c] a
slowdown in Chinese economic growth and its influence on US trade and 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. Yellen’s
easy money comments notwithstanding, the Fed is apparently maintaining its
‘tapering’ policy---which is a plus, in the sense that it’s better late than
never. On the other hand, I regard Yellen’s
comments which ignored tapering as simply more muddying of the policy waters;
thereby reinforcing my thesis that (1) the Fed will once again bungle the
transition process, (2) given the extremes to which QEInfinity went, the
consequences will also likely be extreme, (3) 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
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 up,
(2)
consumer: weekly
retail sales improved; weekly jobless claims were better than estimates,
(3)
industry: the April Markit PMI services index was up
but slightly less than anticipated while the April ISM nonmanufacturing index
was up and better than expected; April wholesale inventories and sales were a
plus,
(4)
macroeconomic: the March trade deficit was down but a
bit less than estimates; first quarter productivity fell more than forecast and
unit labor costs soared.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16583, S&P 1878) performance was mixed this week (Dow up,
S&P down), perfectly illustrating the prevailing investor schizophrenia. That is not necessarily bad; after all, we
have seen this play before in the current bull market. However, there are a growing number of
divergences, not the least of which are the performances of the small cap
stocks and bonds. In addition, the DJIA
has hit its all-time high four times and been repelled and the S&P
continues to build a head and shoulders formation.
Nevertheless, neither
of the senior Averages are threatening to break below their major trends. The S&P closed within uptrends cross all
timeframes: short (1828-1995), intermediate (1780-2580) 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 down; breadth improved, in particular the flow of funds indicator. The VIX fell and is again nearing the lower boundary
of its short term trading range. Of
course, this is the twelfth time it has done this in the last year and a half
and the second time in as many weeks. If
it does manage to bust through the lower boundary of its short term trading
range, it would be a plus for stocks. It also finished below its 50 day moving
average and within an intermediate term downtrend.
The long Treasury
took a rest this week, trading lower. However,
it remains in a short term uptrend, above its 50 day moving average and within
an intermediate term downtrend. This
week’s pin action does raise the question as to whether the bond market has
been sending a signal that something is amiss.
That said, I see no reason to doubt that thesis unless the lower boundary
of its short term uptrend is violated.
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: stocks
have now experienced a two week pause---not that unusual especially since the
Averages are banging up against their all-time highs. Clearly, those highs are posing some stiff
resistance, which I wouldn’t think was all that unusual if it weren’t for the
increasing number of divergences.
And this from
Chris Kimble:
‘If you are curious Chris Kimble, who
runs a charting service, was noted by Yahoo Finance as saying there has only
been twice in the past 35 years when the NYSE is hitting new high as the
Russell 2000 falls below the 200 day moving average - and both those years are
pretty infamous (2007, 1999). Bad things happened right after; now this is a
very small sample size but those were 2 major peaks so if 2015 turns out badly
... it certainly will be an
interesting indicator to watch go forward.’
However, as I noted
this week, as long as the Averages are holding well within their primary
trends, there is no reason to question direction. So my assumption remains that they 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 (16583)
finished this week about 41.4% above Fair Value (11725) while the S&P (1878)
closed 29.0% 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 remains upbeat and supportive of our economic forecast. Regrettably, when I use the output of our
Economic Model, our Valuation Model shows
equities in general to be substantially overvalued. To be sure, investors are, at the moment,
paying far more attention to the Economic Models than the Valuation Models; and
who knows how long that can go on. That said, there are a host risks facing the
Market, all of which have a high enough probability of occurring that the
current Goldilocks environment could be over in a flash.
The Fed is at
the top of the list of those headwinds. QEInfinity
is nothing short of a Frankensteinian experiment with the risk that it could
end equally as bad. Indeed, I think the
Fed knows that it is in uncharted waters and has no clue how to resolve this
situation. I think that this week’s
Yellen testimony reflects that: telling us that the Fed will remain easy while
simultaneously tightening (tapering) and hoping we are too stupid to see the
contradiction. I continue to believe that
this will end badly as every other transition from easy to tight money has,
with the Markets bearing the brunt of the ill effects.
Of course, the
Fed isn’t the only central bank capable of mischief. Japan’s version of QEInfinity is even more
egregious than our own. It is wrecking
the Japanese economy taking the middle class down with it. 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---the latest ECB meeting in which it declined to lower
interest rates being a perfect example. 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 central
bank is the only adult in the central bank community---its latest policy move
being to re-inject moral hazard into its financial system. While that is likely to inflict pain on a
short term basis, the magnitude of that pain will likely be less than would
occur if it did nothing. As a major
trading partner that pain is apt to felt in the US. Perhaps more ominously, an unwind of the yuan
carry trade could result in some severe financial strains in the proprietary
trading community.
Putin continues
to have his way in Ukraine, pursuing the re-acquisition of territory lost in
the dissolution of the Soviet Union.
Meanwhile, given our own inept foreign policy and the heavy dependence of
Europe on Russian gas, I see little standing in his way. I just hope that Obama can avoid being
humiliated on the public stage and Putin won’t attempt to inflict additional
pain via higher oil prices.
Finally, despite
multiple explanations from the punditry (none of which I found adequate), I remain
confused/concerned about the recent pin action in the bond market. As I have noted, the bond market historically
has been much better at price discovery than the stock market; and I fear this
a sign that the bond market is at long last refusing to buy the Fed’s routine
(i.e. the Fed is not easy and tightening will negatively impact an already
sluggish economy).
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 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 16583 1878
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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