The Closing Bell
6/21/14
Next week is the last of my month long hiatus. We are headed to the beach for our annual
anniversary fling. Nothing next
week. I will be watching the Markets and
in communication if necessary. See you
Monday June 30.
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 16045-17524
Intermediate Uptrend 16271-20636
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 1875-2045
Intermediate
Term Uptrend 1821-2621
Long Term Uptrend 757-1974
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. Not a
lot of data this week; and what we got was mixed: positives---weekly retail
sales, weekly jobless claims. May industrial production, the June NY and
Philadelphia Fed manufacturing indices; negatives---May housing starts, weekly
mortgage and purchase applications, May CPI, June leading economic indicators
and the first quarter trade deficit; neutral---none.
The standout
datapoints were: (1) stats on two key sectors of the economy [May industrial
production and May housing starts] were released. One a plus, the other a negative. Thus, keeping the ‘slow sluggish growth’
scenario alive and well, and (2) May CPI.
This put its six months rolling average over the Fed’s 2% target
range. One more high reading will put
the year over year average at the same threshold.
The latter would
suggest a tightening in Fed monetary policy.
But as you know, Yellen dismissed this data as ‘noise’. As I noted in Thursday’s Morning Call, I
believe that this is a solid signal that the Yellen Fed will stay too easy, too
long and will follow in the footsteps of its predecessors, botching the
transition to a normalized monetary policy.
More on that later.
It also raises
the risk that the economy may be about to suffer another period of
stagflation. Remember the economic
narrative of the last six weeks has been whether or not the US growth rate will
slow. While I haven’t altered our
forecast, the recent data leave open that possibility (risk). Now
with the pickup in inflation, we may face the risk of an economy still
restrained by fiscal, regulatory and monetary mismanagement but with excess
liquidity finding its way beyond the securities markets. Bottom
line---I leave the outlook in tact but the yellow light flashing:
‘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.’
Weekly
recession indicator (short):
The pluses:
(1)
our improving energy picture. The US
Clearly, this
factor becomes even more important as the turmoil in Ukraine and Iraq threaten
global oil supplies.
The
negatives:
(1) a
vulnerable global banking system. It was
a slow week for bankster malfeasance.
‘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. While
nothing related to directly to fiscal policy is happening, the election season
has begun with a stunner---the defeat of house majority leader, Eric Cantor in
the Virginia GOP primary. I don’t want
to read too much into this event. But
the least we can say is that immigration is likely to be a much bigger issue in
2014 than in previous elections.
I will note,
however, that my contention has been that the only way this country re-sets
itself to a more fiscally responsible, less intrusive course was to throw out
the whole ruling class or enough of it to scare the shit out of the rest. I have no idea whether or not the Cantor
defeat was a first step in that direction.
But we can hope.
And:
(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.
The Fed gave
its first clear signal this week that there is nothing new about the current
regime and that it intends to pursue the same reactive policies of the past
Feds, insuring that it will be a day late and a dollar short with any
tightening move and thereby increasing the risk of inflation going to unhealthy
levels. The tipoff: (1) Yellen
dismissing the recent rise in inflation data as ‘noise’, (2) her refusal to
provide any guidelines whatsoever as to the timing of any prospective monetary
tightening [‘it depends’] and (3) her unwillingness to comment on the
overextended metrics of the securities’ markets.
My bottom line
is that I continue to believe that the Fed hasn’t a clue how to extricate
itself from its current historically overly expansive monetary policy. That, in turn, has rendered it frozen in the
headlights of oncoming inflation.
QEInfinity is not likely to end well, especially for the Markets.
http://www.nakedcapitalism.com/2014/06/feds-ever-burgeoning-market-manipulation-support.html (must read)
The latest from Marc Faber
(medium):
(3)
rising oil prices.
This risk is now front and center brought on by the turbulence in
Ukraine and Iraq. Pipelines and
refineries are being destroyed as we speak; and, at least in the case of Iraq,
sooner or later, the oil fields themselves may be in danger of lost production.
Given our ongoing
diplomatic ineptitude, I am concerned that things will only get worse. World energy supplies are now in danger of
disruption from either a cynical economic/political move from Russia or a
splintering of the Middle East or both.
Even if that doesn’t occur, oil prices may likely be driven higher and
that is not going to help our rising inflation problem.
Iraq just got
messier (medium):
Ukraine just
got messier (medium):
(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.
China’s real
estate market is imploding. On top of
that vast quantities of warehoused commodities that were used as collateral for
loans have disappeared; and all signs are that this problem also exists at
multiple warehouses. Even worse it
appears that these commodities could have been used as collateral for multiple
loans. I have no idea the extent to
which this touches the banking systems outside China; but if it does, our banks
could be in for another round of losses/failures. Even if it is confined to the Chinese banking
system, the potential losses there would likely be sufficient to threaten that
country’s economic growth with at least some spillover effect on the rest of
the globe.
And (must
read):
The ECB
recently lowered interest rates and promised that some new form of QE was in
the offing. Why it believes this will do
any good when (1) the same exact policies haven’t worked in the US or Japan and
(2) its sovereigns are already overly indebted and its banks over leveraged, is
beyond me. http://www.realclearmarkets.com/articles/2014/06/19/draghi_hits_savers_to_salvage_faux_recovery_101132.html
And:
I remain
dumbfounded 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 even
attempted the unwinding process and the last chapter has not been written on the
Chinese real estate implosion.
Bottom line: the US economy continues to progress. However,
Fed policy (or perhaps a lack thereof) remains a growing 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 are mounting.
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 trying to
do something to wind down its expansive monetary and fiscal policies. However, the commodity re-hypothecation
scandal could very well get out of hand and negate any efforts by the
authorities to do the right thing.
Whatever the outcome, some heartburn seems inevitable, [c] the ECB looks
to me like it has the same deer in the headlights syndrome as our own Fed. What they have done so far hasn’t
worked. Indeed, like Japan and the US,
it hasn’t worked because it was the wrong thing to do---trying to save the
banking class, greedy politicians and other rent seekers have only made things
worse.
Finally, military/political
turmoil reigns supreme in Ukraine and Iraq.
I have no idea if either or both drive up energy prices further; but I
believe that the odds grow every day that they will. And that won’t be good for economic growth.
In sum, the US
economy remains a plus, though the recent growth and inflation numbers are somewhat
worrisome. Unfortunately, those are not
the only potentially troublesome headwinds.
This week’s
data:
(1)
housing: May housing starts were well below
expectations; weekly mortgage and purchase applications were both down,
(2)
consumer: weekly
retail sales were up; weekly jobless claims were better than estimates,
(3)
industry: May industrial production was above forecasts
as was the June NY and Philadelphia Fed
manufacturing indices,
(4)
macroeconomic: May CPI was hotter than anticipated; June
leading economic indicators were less than consensus; the first quarter trade
deficit was above expectations.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16947, S&P 1962) had a great week, finishing above their 50
day moving averages and remain within uptrends across all time frames: short [16045-17524,
1878-2045], intermediate [16271-20636, 1821-2621] and long term [5081-18193,
757-1924].
Volume on Friday
was up, largely as a function of quadruple witching (option expiration);
breadth improved. The VIX rose, but
still closed within its very short term, short term and intermediate term
downtrends, below its 50 day moving average and near the lower boundary of its
long term trading range. 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
had a roller coaster week. On Friday, it
bounced off its previous low and back above its 50 day moving average. However, it remains below the lower boundary
of its short term uptrend. A close below
that trend line on Monday will confirm its break. At this point, the TLT chart is sufficiently
confusing that I am uncertain about the near term direction---which means that
it is also unclear whether or not the bond guys are buying the higher inflation
thesis.
While GLD was
down fractionally on Friday, it had already executed a major turnaround for the
week, breaking out of its very short term and short term downtrends and above
its 50 day moving average. Unlike the
TLT, it left little doubt about a change in direction. That said, GLD can be quite volatile; so I am
going to be patient in the interest of not getting suckered by a head fake.
Bottom line: technically
speaking, the Averages acted superbly this week, overcoming an already
overbought condition and multiple servings of bad news. That said, it continues to advance on lousy
volume and in spite of a growing number of divergences. Of course, all these non-confirming
indicators could re-sync with the indices.
But the point is that at present they are becoming less not more in
sync. My assumption remains that the
Averages will assault the upper boundaries of their long term uptrends if not
the next set of ‘round numbers’ (Dow 17,000/S&P 2000).
Our strategy remains to do nothing save taking
advantage of the current momentum to lighten up on stocks whose prices are
pushed into their Sell Half Range or whose underlying company’s fundamentals
have deteriorated.
A word of
caution. If you absolutely, positively
just can’t help but buy something be sure to set very tight trading stops.
From the
Sentiment Trader:
‘Precious metals
jumped on Thursday, with gold showing its largest one-day gain in more than six
months. In the past 30 years, the S&P 500 has closed at a 52-week high on a
day gold spiked the most in six months 6 other times. All 6 saw stocks decline
over the next three weeks, averaging -2.1%. The dates were 6/7/89, 9/14/92,
2/13/97, 11/4/10, 7/22/13 and 9/18/13.’
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (16947)
finished this week about 44.2% above Fair Value (11750) while the S&P (1962)
closed 34.4% overvalued (1459). 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 continues to reflect a slow sluggish recovery though it is now faced
with the potential of a rise in inflation.
At the moment, investors seem positively giddy about these
prospects. To be clear, I continue to stick
with our economic outlook. 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 done little (save QE1) to help the economy and has made a mess of asset
pricing (the securities markets). With
this week’s FOMC meeting, it appears that it will now ignore mounting
inflationary forces until it is too late to prevent the resultant damage. 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 continues to talk up the greatest
expansion in money supply by a major nation since the Weimar Republic. The only thing saving it from a similar
outcome is its productive capacity (at least there are some goods to chase). We haven’t seen the end game to this experiment;
but any further impairment to its economy could impact our own while a forced unwind
of the yen ‘carry trade’ 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 have
been trying to do the right thing by wringing speculation out of its financial
system. Regrettably, it is now faced
with a second problem---commodity re-hypothecation, i.e. using the same
collateral to back multiple loans. To
date, it has been traced to a series warehouses in only one Chinese city; but
the rumor mill is speculating this scandal is more widespread. I have no clue how either or both of these
difficulties will ultimately impact that country’s banking system. Clearly the risk is of a Chinese Lehman
Brothers and its effect on the global financial community.
Ukraine has been
replaced by Iraq as the source of rising oil prices. How much worse conditions can get in Iraq is
anyone’s guess. But if you take the ISIS
jihadists at their word, the answer is a lot.
Plus we don’t know if Putin will use the Middle East crisis to help
Russia put the squeeze on Ukraine or even the EU. Whatever the outcome, a continuing advance in
oil prices will not help our inflation or consumer discretionary spending
numbers.
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 if this week’s bond
and gold market signals are correct, our inflation forecast may have to be
revised up). 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.
For the bulls (medium):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 6/30/14 11750 1459
Close this week 16947 1962
Over Valuation vs. 6/30 Close
5% overvalued 12375 1531
10%
overvalued 12925 1604
15%
overvalued 13512 1677
20%
overvalued 14100 1750
25%
overvalued 14687 1823
30%
overvalued 15275 1896
35%
overvalued 15862 1969
40%
overvalued 16450 2042
45%overvalued 17037 2115
Under Valuation vs. 6/30 Close
5%
undervalued 11162 1386
10%undervalued 10575 1313
15%undervalued 9987 1240
* 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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