The Closing Bell
7/5//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 16145-17624
Intermediate Uptrend 16416-20748
Long Term Uptrend 5083-18464
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1895-2062
Intermediate
Term Uptrend 1837-2637
Long Term Uptrend 762-1999
2013 Year End Fair Value 1430-1450
2014 Year End Fair Value
1470-1490
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 44%
High
Yield Portfolio 53%
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---the June ADP
private payroll report, June nonfarm payrolls, the May trade deficit and the June Markit PMI; negatives---weekly
mortgage and purchase applications, the June ISM manufacturing and nonmanufacturing
indices, May construction spending and May factory orders; neutral---weekly
jobless claims.
The only standout
datapoints were the big jump in the ADP private payrolls report and June
nonfarm payrolls. There is good news and
bad news there. It is great that employment
is picking up; unfortunately employment is a lagging indicator---so it tells us
nothing about the near term economic outlook.
That said, there was nothing that would alter our forecast.
However, the
prospects for a rising inflation rate are still with us. This notion is being supported by the recent
pin action in the bond and gold markets.
While, it is too soon to raise our inflation outlook, the yellow light continues
to flash.
‘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.’
Recession
probability model (short):
The pluses:
(1)
our improving energy picture. The US
This factor is
increasing in importance as the turmoil in Ukraine and Iraq threaten global oil
supplies. On the other hand, the Canadians
are revising their own energy strategy from exporting oil to the US [via the
Keystone pipeline] to selling it to China---which clearly lessens the reserves
the US will have to draw on in the event of a global energy crisis. Another excellent move for hope and change.
The
negatives:
(1) a
vulnerable global banking system. This
week, BNP Paribas agreed to a fine of $9 billion for aiding and abetting
financial transfers with sanctioned nations.
While some analysts argue that this action by the US ultimately undermines
the strength of the dollar as a global medium of exchange [transactions can
take place in another currency which the US can’t trace], I think embargos are
a lot safer means of bringing rogue nations to heel than military action. Furthermore, I have my doubts that long term
the dollar will lose its place as the global currency for taking actions that
benefit most nations, in particular those with banking systems large enough to
thwart an embargo in the first place.
In addition, it
appears that the DOJ is about to sue Citicorp for mortgage securities fraud.
‘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. With
election season in full swing, nothing is likely to happen to alleviate the
problems of an inefficient tax code, too much irresponsible spending and too
much government regulations. The one
bright spot is that the growing economy is generating sufficient tax revenue to
drive down the budget deficit.
On nonfiscal
matters, the good news is that Obama has been unable to get measures that He
favors through the normal legislative process and indeed has suffered a couple
of setbacks from the Supreme Court. The
bad news is that He now appears intent on using executive mandate to accomplish
His goals. I am not sure how
constitutional this all is; although I have no doubt that our Founders are
collectively rolling over in the graves.
(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.
I stated in the
last Closing Bell that I thought that the Fed had begun to show its true colors,
i.e. 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.
Yellen’s
remarks this week to the IMF support that notion. Indeed, she made a point of saying that
financial stability was better managed via macroprudential policies; which is
to say, nonmonetary policies. Forget the
fact that any financial instability will likely come as a result of the
unprecedented expansion of the Fed’s balance sheet. So in effect, Yellen is saying that the Fed
may have created the conditions for financial instability but it is not going
to use monetary policy to cure it.
Leaving her and the rest of Fed the luxury of continuing to pump up the
money supply/leave interest rates low.
Question: where
were all those macroprudential policies during the last two financial
crises? And why do we [she] think that
they will be there if another happens tomorrow?
I got to believe that when the Fed chairperson starts disavowing any
knowledge or liability for financial instability, her sphincter is having
spasms.
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.
The Fed’s dilemma (medium and
a must read):
(3)
rising oil prices.
Violence in Ukraine and Iraq remain in the headlines and with that, the
risk of a development that would negatively impact global oil supplies. To be sure, prices have already reacted to ongoing
events and to date, the price of oil [gasoline] hasn’t reached the ‘uncle’
point for consumers. Indeed, this week, prices declined as the news flow became
less intense. Hence, this risk is still
a ‘potential’ one. That said, given our continuing
diplomatic ineptitude, I am concerned that things could get worse.
The latest from
Ukraine (short):
Now Kuwait?
(short):
(4)
the sovereign
and bank debt crisis in Europe and around the globe. So far, Abe’s multiple policy ‘arrows’ haven’t
done jack shit to halt the Japanese economy’s continued descent into recession
and deflation. He is now stumbling
around trying to find a new ‘arrow’ but to little avail. If Japan isn’t a world class example that
monetary policy is the problem not the solution, I don’t know what is.
China’s real
estate market continues to imploding as housing prices slid further in June. In addition, we still don’t know the extent of
the damage to financial system from those vast quantities of warehoused
commodities that were used as collateral for [multiple] loans and have since
disappeared. We also don’t know if this problem also exists at multiple ports.
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.
Thoughts on
long term Chinese economic policy (long but a very good read):
Despite the
recent further lowering of interest rates by the ECB, the economic dataflow has
not improved. Of course, it has only
been a month; so it is too soon to declare this policy move a failure. Further, many thought that the ECB would
approve some version of QE at its June meeting.
Well, that didn’t happen. Of
course, neither of these policy instruments [lower interest rates, more monetary
expansion] have worked anywhere else in the world. So it is a fair question to ask why the ECB
expects it to work there. In addition, neither
effectively address the twin issues of over indebted sovereigns and overleveraged
banks
Another gem
from the IMF (medium and today’s must read):
‘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 despite
little to no help from fiscal and monetary policy. Plus the risk is rising that
it will soon have to battle either inflationary forces brought on by QEInfinity
or a recession resulting from the unwinding of QEInfinity of both [stagflation].
Overseas, the
environment is worse. Japan is sinking
into recession at the same time its central bank is burning up its presses
printing money. China is trying to do
something to wind down its expansive monetary and fiscal policies. But either a collapsing housing market or the
commodity re-hypothecation scandal or both 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. The ECB appears intent on
mimicking the failures of our Fed and the Bank of Japan and, to date, has
gotten the same results---which is to say, nada.
Finally, violence
continues 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.
Peak optimism or
peak propaganda? (medium):
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
both down,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims rose marginally; June nonfarm
payrolls grew much more than anticipated; the June ADP private payroll report
was well ahead of forecasts,
(3)
industry: both the June ISM manufacturing and nonmanufacturing
indices came in slightly lower than estimated while the June Markit PMI was
somewhat above; May construction spending was much lower than anticipated; May
factory orders fell more than expected,
(4)
macroeconomic: the May US trade deficit was lower than
forecast.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17068, S&P 1985) had another great week, finishing above
their 50 day moving averages and remaining within uptrends across all time
frames: short [16145-17624, 1895-2062], intermediate [16416-20748, 1837-2637] and
long term [5088-18464, 762-1999]. Plus
the Dow closed above 17000 and the S&P is a whisker away from the upper
boundary of its long term uptrend.
Volume on Friday
was up slightly; breadth improved. The
VIX fell, remaining within its very short term, short term and intermediate
term downtrends, below its 50 day moving average and extremely close to the
lower boundary of its long term trading range.
In the meantime, internal divergences within the Market persist. The latest check of our internal indicator
shows that in a 146 stock Universe, 45 are at all-time highs, 24 are almost
there and 77 aren’t close.
The long Treasury
got obliterated this week. At Friday’s
close, it confirmed the break below the lower boundary of its short term
uptrend. That re-sets it to a trading
range. Unfortunately, it also closed
below its 50 day moving average. It also
finished at the same level as its prior low.
So if it moves down further, it will make a new lower low after having
just made a new lower high. That in turn
will quickly re-set the short term trend to down. The TLT chart appears to be gaining some
clarity which, regrettably, appears to be to the downside.
GLD was down on
Friday, closing back into the prior week’s trading range. That isn’t necessarily terrible news. But GLD just hasn’t managed any follow
through momentum to the upside. Unlike
the TLT, its chart is getting murkier---making me wonder if we did not yet
again get a head fake from GLD.
Bottom line: technically
speaking, the Averages have investors tip toeing through the tulips. All-time
highs and big ‘round’ number upside objectives are on everyone’s mind. Beneath the surface though, volume is light
and divergences grow. As I noted in the last
Closing Bell: ‘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.’
The bond and
gold markets also continue to muddy the picture. Last week, GLD was firmly supporting the
stock guys’ scenario: growth and inflation.
This week, it seems to be having second thoughts. On the other hand, last week bonds acted as
if they doubted the growth and inflation thesis. This week, they were absolutely
trashed---suggesting otherwise. This pin
action combo keeps me a bit uncertain about what is and is not being
discounted. That said, the damage to the
bond market was sufficient that I am lightening up on the muni bond ETF in our
ETF Portfolio; I am sitting on my hands with respect to GLD.
On stocks, 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.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17068)
finished this week about 45.0% above Fair Value (11775) while the S&P (1985)
closed 35.7% overvalued (1462). 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.
For the moment, I continue to stick with our economic outlook. Unfortunately,
our Valuation Model has this scenario 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.
It would seem that investors have all these issues discounted. However, when stocks are priced for
perfection, it doesn’t take much of an exogenous event to turn psychology on
its head; and, suddenly, all those ‘discounted’ problems come back to haunt.
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). It
made clear in its recent FOMC meeting which Yellen reinforced this week at the IMF
summit that it will 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. The deeper Japan sinks into
recession/deflation (and it sunk further judging by this week’s economic data)
the more desperate its policy machinations.
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, it has done little to nothing to back up that
statement. Expectations were for some
sort of QE to come out of the ECB June meeting.
Didn’t happen. Further, it seems
oblivious to its main problems: its heavily indebted sovereigns and its many
overleveraged banks. My concern here is about a disruption
in our financial system resulting from problems in either.
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.
The turmoil in Ukraine
and Iraq have put upward pressure on oil prices. Although, to date, markets have handled these
problems fairly well. As long as the
violence in both areas remains reasonably under control, oil/gasoline prices in
the US are unlikely to reach a level that starts to impact economic activity. Helping matters out in the short term has
been the opening up of Libyan oil reserves for export. That said, the last act has not been played
in either Ukraine or Iraq; and either conflict could blossom out of control which
could push prices to a level that effects our 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 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.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 7/31/14 11775 1462
Close this week 17068 1985
Over Valuation vs. 7/31 Close
5% overvalued 12363 1535
10%
overvalued 12952 1608
15%
overvalued 13541 1681
20%
overvalued 14130 1754
25%
overvalued 14718 1827
30%
overvalued 15307 1900
35%
overvalued 15896 1973
40%
overvalued 16485 2046
45%overvalued 17073 2119
Under Valuation vs. 7/31 Close
5%
undervalued 11186 1388
10%undervalued 10597
1315
15%undervalued 10008 1242
* 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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