The Closing Bell
8/2/14
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 ????
Intermediate Uptrend 16624-20922
(?)
Long Term Uptrend 5101-18464
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend ????
Intermediate
Term Uptrend 1858-2658
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. This
week’s data releases weighed to the constructive side: positives---weekly
purchase applications, weekly retail sales, July consumer confidence, July
consumer sentiment, the ISM
manufacturing index, the July Market flash services PMI, the July Dallas Fed
manufacturing index and second quarter GDP: negatives---weekly mortgage
applications, the May Case Shiller home price index, weekly jobless claims and
second quarter employment costs, the July Chicago PMI and July construction
spending; neutral---July pending home sales, the July ADP private payroll
report, July nonfarm payrolls and July personal income and spending.
A detailed look
at the second quarter GDP report (medium and a must read):
The standout
numbers this week were second quarter GDP, July nonfarm payrolls, personal income
and spending and second quarter employment costs along with the FOMC meeting. Leaving the Fed aside for the moment, all of
the other datapoints support our forecast of a sluggishly growing economy and
suggest that the recent series of poor stats was another one of those hiccups that
we have experienced in this recovery but to which there is no follow through. I am not going to take recession off the table
just yet; but there is no longer a flashing yellow light.
On the other
hand, second quarter employment costs point to building inflationary pressures
and directly support our original thesis that inflation will ultimately prove
the culprit of QEInfinity. Of course,
the FOMC statement suggesting an interest rate hike is nowhere in the offing only
reinforces that scenario.
As a result, I am
almost back to what has been our base forecast for the last three years with emphasis
on the Fed appearing to be in the process of botching the transition to normal
monetary policy yet again.
Our forecast:
‘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.’
Update
on big four economic indicators:
And this from David
Stockman (medium):
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a
vulnerable global banking system. This
week, the Bank of
Portugal said there are indications of “seriously harmful acts of management”
at the lender [Espirito Santo] and a failure to comply with the central bank’s
directives.
The point of
this keeping this potential negative in front of us is to underline [a] the
wanton disregard for rules and regulations {most designed to either prevent a
financial meltdown or the damage depositors} by bank management and [b] the
inability of the regulators to stop this behavior before the fact {read
disastrous consequences}.
‘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.’
With congress
starting a five week recess in which much campaigning will be primary objective,
both parties scrambled to present legislation that would score political
points; to wit (1) the GOP introduced a half assed immigration bill and voted
to sue Obama over misuse of executive power and (2) the dems introduce their
own half assed legislation designed to prevent companies from moving overseas
to avoid taxes.
Clowns to the left of me, jokers to the right.
I am an equal
opportunity critic here. Obama, Reid and
Boehner are, in my opinion, a disgrace to their office. Ninety-nine percent of comments by
politicians that I see, hear and read are garbage. It is small wonder that the economy is
struggling and that the US is a laughing stock to the rest of the world. The only good news is that these morons are
so incompetent that nothing is getting done [he who rules least, rules
best]. I continue to maintain that the
only solution is the throw every last one of these guys out on his can.
The causes of
inequality (medium):
(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 and did little to alter the outlook for policy. It tapered another $10 billion per month and
left wide open the issue of timing of a rate hike. Which leaves my conclusion on Fed policy
unchanged: the Fed has no clue how to extricate itself from its current
historically overly expansive monetary policy.
As you know, I have
long expected that ‘the botched return to normal’ scenario would play out with
the Fed staying too loose too long and that would lead to higher inflation. Last week, I introduced the notion that the
recent softness in many of the primary economic indicators could portend
recession. This week’s data went a long
way to dispelling that thesis. I am not
taking it off the table with just one week of contrary stats; but the multitude
and quality [primary indicators] was such that I think the odds of slower to no
growth are much less than at this time last week.
That said, I continue
to maintain that the end result of the current extraordinarily irresponsible
monetary experiment would likely be much greater for the Markets than for the
economy. The point being that once
investors realize that there is no goldilocks outcome, the Markets will take it
in the snoot however gentle any economic decline or advance in inflation.
The consequences of substituting
debt for income (medium):
http://www.zerohedge.com/news/2014-07-31/substituting-debt-income-not-success-its-failure-epic-scale
(3)
rising oil prices.
Violence in Ukraine and the geopolitical ramifications of the US/EU
imposed sanctions on Russia as well as the continuing turmoil in Iraq and
Israel/Palestine remain a threat to global oil/gas supplies/prices. To date, none of this has served to disturb
the oil market. However, all of these
issues remain unresolved. Indeed they
continue to deteriorate---which leaves open the prospect that we still may face
higher prices.
Clueless in
Gaza (medium):
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. Europe remains a trouble
spot. The Espirito Santo problem grows. Economic data this week did not make for good
reading. And the EU is walking a tight
rope with Russian sanctions. If he is so
inclined, Putin can make this winter miserable for the Europeans. In
addition, the risk is also still there that conditions relating to sovereign
debt and overleveraged banks could deteriorate sufficiently to plunge Europe
into an economic crisis. So far, the EU has ‘muddled
through’. Indeed, that is our forecast;
but potential risks remain from multiple sources.
Here is an
interesting take on why the EU bureaucrats want an end to austerity (short):
Why bond yields
are so low in Japan and the EU (short):
The news out of
Japan this week was no better than that from the EU. Industrial production fell off of a cliff
precisely at the time the government forecast a turnaround in economic activity. That doesn’t mean that it still can’t happen;
but until the stats improve, a recession or worse remains the risk.
The Bank of China
appears to have unfurled a full on QE.
While Chinese stocks are rallying, the yuan carry trade may be in danger.
Bottom line: the US economy continues to progress despite
little to no help from fiscal and monetary policy. As you know, recent weakness
in the dataflow had me concerned that its already sluggish growth rate could
suffer additional softness. However, the strength in several primary indicators
this week goes a ways towards dispelling that notion. And given the Fed’s hesitancy to further
tighten its expansive monetary policy, reinforces the risk that at some point we
will be battling inflationary forces brought on by QEInfinity. I am not dismissing the recession alternative
scenario; but after the data we got this week, it seems the less likely.
Overseas, the
environment is worse. The Portuguese
bank insolvency, terrible economic data out of the EU and the threat of Russian
reprisal over sanctions highlight the risks that still exist to the EU’s overly
indebted sovereigns and overly leveraged financial system.
Japan’s
monetary/fiscal policies make the US look like a paragon of virtue. How that country’s economy avoids imploding
is a mystery to me---which is not to say that it won’t.
Finally, violence
continues in Ukraine and throughout the Middle East. Somewhat surprisingly, the Markets have taken
this strive in stride---at least until last Thursday. With respect to the former, the whole issue
of sanctions confounds me. It appears
that it has gone far enough that someone now has to blink---and my money is on
Obama. I don’t think that will be well
received by the Markets. On the other
hand, rumors abound that the Germans and Russians are negotiating a resolution
to this crisis. Ah if only that is the
case. Then the worse we will have to
endure is a lot of political speak from Obama on how He was responsible for the
whole thing.
In sum, the US
economy remains a plus, though the risks of inflation are growing. Unfortunately, that is not the only potentially
troublesome headwinds.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
mixed; June pending home sales were down but in line; the Case Shiller home
price index was down versus forecast of being up,
(2)
consumer: weekly
retail sales were up; the July ADP private payroll report showed employment up
but by less than estimates as did July nonfarm payrolls; July personal income
and spending grew in line; weekly jobless claims rose more than anticipated;
Consumer Confidence was much stronger than forecasts while Consumer Sentiment
was slightly above consensus,
(3)
industry: the July Markit flash services PMI was
slightly better than expected as was the July Dallas Fed manufacturing index as
was the ISM manufacturing index, the July Chicago July PMI fell off a cliff as
did July construction spending,
(4)
macroeconomic: second quarter GDP smoked the estimates,
while employment costs increased more than anticipated.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16493, S&P 1925) had a rough week. Both took out their 50 day moving
averages. The Dow broke its short term
uptrend, re-setting to a short term trading range. It also closed below the lower boundary of
its intermediate term uptrend for the second day. A finish there on Monday will confirm the
break of that uptrend and a re-set to a trading range. The S&P confirmed the break of its short
term uptrend, resetting it to a trading range.
That leaves the
Averages in sync with the break of their 50 day moving averages and short term
uptrends. If there is no rebound on
Monday, then they will be out of sync on their intermediate term uptrends; but
will remain in harmony of their long term uptrends [5101-18464, 762-1999].
Volume on Friday
was down, breadth mixed---but stocks are very oversold. The VIX was up again, remaining above its 50
day moving average and within a very short term uptrend. It is still in a short term downtrend though
it closed near its upper boundary. A
break of that resistance level would point to more weakness in stocks.
The longer a
stock run up lasts, the larger the correction (short):
After weakness
early in the week, on Friday the long Treasury bounced hard off the lower boundary
of its short term uptrend and closed right on the upper boundary of its former
short term trading range. I think that this
pin action is a plus and raises my confidence in strength of the uptrend;
although I remain nervous based on its recent confusing performance. It also finished above its 50 day moving
average and within an intermediate term trading range.
As I noted last
week, the importance of the bond market’s performance is what it tells us about
what bond investors think about the economy.
Right now, it seems to be saying that either there is a risk of a
geopolitical flare up or that economic risks are weighed toward recession
versus inflation. If the latter, then
that obviously doesn’t square with my interpretation of this week’s economic
data. Of course, it could be the former;
and for the moment, I am in that camp.
However, as I noted in the Economics section, I have not totally
dismissed the recession scenario.
More on the
underperforming high yield bond market (medium):
GLD was up on
Friday, closing above its 50 day moving average, within a short term trading
range and an intermediate term downtrend and appears to be building a pennant
formation.
Bottom line: the
technical action this week was fairly disruptive: 50 day moving averages were
breached, short term uptrends were broken and the Dow is two days into a three
day challenge of its intermediate term uptrend.
By historical standards, that doesn’t mean that the bull market is over
and mean reversion is upon us. However,
given the damage, if you are fully invested, you might want to be rethinking
that position unless you are a long term follower of ‘buy and hold’.
It also means
that stocks could be in the process of adjusting price to account for all those
oft mentioned divergences. The question
is will those divergences quickly correct themselves (meaning this sell off
will be a mild one) or if they stay same or, God forbid, get even worse
(meaning that this could be the beginning of ‘the big one’). The good news is that our Portfolios are currently
positioned for this sell off and we can deal with whatever emotional repercussions
there are calmly and without the risk of panic.
That said, I want
to reiterate that it is way too soon to be betting on mean reversion and way
too soon to panic. It is a time to look
very carefully at your holdings, be sure
that they are the highest quality, reasonably priced and that you won’t be sad
to own them 10%, 15%, 20% lower---in other words, be sure that you know what
you own.
Our strategy remains to do nothing. It is too early to be making a Buy List but
not too late to Sell stocks that are near or at their Sell Half Range or whose
underlying company’s fundamentals have deteriorated.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (16493)
finished this week about 39.7% above Fair Value (11806) while the S&P (1925)
closed 31.3% overvalued (1465). 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.
I think that this
week’s plethora of data added some clarity to the economic picture in the sense
that the likelihood of recession now seems less. On the other hand, the odds of a too easy Fed
leading to higher than expected inflationary pressures is back to being the
leading economic risk from Fed policy.
If events play out that way, I believe that a reversal in the policy (historically
easy money) that drove asset prices to unrealistic levels will have a negative impact
on those same extremely overvalued assets.
Furthermore, the
economy and Fed aside, there is no shortage of other risks that could
dramatically impact valuations. The
Japanese economy is a mess and getting worse daily. Yet its government persists in pursuing
policies that haven’t worked for over a decade.
Go figure. While we can’t know
the extent of any spillover effects on the US economy, a further slowdown from
a major trading partner will clearly not help our own growth rate.
The EU continues
struggling to get out of recession/deflation---witness this week’s inflation
and PMI numbers. In addition, it is now
contending with another bank failure that could prove systemic; and new
sanctions imposed on Russia risks reprisals that would only exacerbate European
growth difficulties. Finally, the lack
of reforms to correct overly indebted sovereigns and overleveraged banks
increases the probability of magnifying any economic problems and their potential
spillover effects on the US.
The China appears
to have joined the QEInfinity ranks---this after a very short lived attempt to wring
speculation out of its financial system.
I have no idea if the recent spurt of monetary/fiscal sanity created
enough economic slack to absorb this new infusion of money without re-stimulating
dicey behavior. We will know soon
enough.
I can’t imagine
the end game to the turmoil in Ukraine and the associated trade war. Until Thursday, global markets and in
particular the energy markets have been unconcerned. Now there appears to be at least a
realization that (1) this US/Russian standoff has reached the point where
someone has to blink and (2) it is not apt to be Putin. The good news is that rumors abound that
Germany and Russian are working on a negotiated settlement. Assuming that occurs and assuming Obama is wise
enough to go along, we could get this trouble spot off our radar. The only consequence being more lost prestige
for the US as Obama once again leads from behind.
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.
Another
unsettling valuation indicator (medium):
Bottom line: the
assumptions in our Economic Model haven’t changed (though our inflation forecast
may have to be revised up and our global ‘muddle through’ scenario seems more
at risk than a week ago). 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.
This
from a long time bull (short):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 8/31/14 11806 1465
Close this week 16493
1925
Over Valuation vs. 8/31 Close
5% overvalued 12396 15385
10%
overvalued 12986 1611
15%
overvalued 13576 1684
20%
overvalued 14167 1758
25%
overvalued 14757 1831
30%
overvalued 15347 1904
35%
overvalued 15938 1977
40%
overvalued 16528 2051
45%overvalued 17118 2124
Under Valuation vs. 8/31 Close
5%
undervalued 11215 1391
10%undervalued 10625
1318
15%undervalued 10035
1245
* 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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