The Closing Bell
8/23/14
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 16331-17158
Intermediate Trading Range 15132-17158
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 Trading Range 1814-1991
Intermediate
Term Uptrend 1881-2681
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, while sparse, were quite upbeat: positives---weekly mortgage
applications, July housing starts, July existing home sales, the July NAHB
confidence index, weekly jobless claims, the Philly Fed index, July leading
economic indicators and second quarter CPI: negatives---weekly purchase
applications; neutral---weekly retail sales.
I supposed that
the fact that the stats this week were overwhelmingly positive is important in
itself. Certainly, they reinforce the
notion of economic growth. However, the
housing numbers bear special attention.
This sector has been the ‘sick puppy’ in the economy. So to have housing starts and existing home
sales trounce expectations is clearly a promising sign that this sector is
starting to catch up and now contributing to any further advance. I say that with the usual caveat that one
week’s worth of data does not make a trend.
Also of note is
the continuing deterioration in the European and Japanese economies. To date, the US economy has been carrying a heavy
burden in the form of domestic fiscal, monetary and regulatory policies and yet
has still managed to grow. The question
in my mind is, can it bear the additional weight of a slowing global
economy? As yet, there is no sign that
it can’t; but I am leaving open the possibility of recession or at least a slowdown
in the already sluggish US rate of advance.
The Fed, which
has been one of, if not the, leading factor in investors’ decision making for
the last three years, drew its share of headlines this week. First on Wednesday, the minutes from the last
FOMC meeting were released. The bottom
line was that they were more hawkish in tone than anticipated due primarily to
the improved flow of economic data, in particular on employment. That was followed by a speech by Yellen at
Jackson Hole which, to summarize, was wishy washy with a hawkish overtone. Taken together that suggests that the Fed may
start to tighten sooner than many now assume---which is fine by me.
As you may know,
Draghi also spoke at Jackson Hole and in his speech, he basically said that (1)
the ECB while will do all it can to prevent recession, it pretty much has
already done all that it could and (2) the next move had to come from fiscal
policy---the cry for fiscal help echoing some of Bernanke’s speeches. The difference being that Bernanke had a lot
more flexibility to manipulate monetary policy and he used every bit of
it. Indeed more than he should have, I would
argue. In any case, there doesn’t seem
to be a QEIV coming from the ECB.
In sum, I am
almost back to what has been our base forecast for the last three years with the
caveat that a slowdown among our major trading partners could adversely impact
our outlook.
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.’
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a
vulnerable global banking system. This
week’s bankster bad guy was Bank of America, agreeing to a $17 billion settlement
over mortgage fraud--- providing yet another chapter in the going saga of wanton
disregard for rules and regulations [most designed to either prevent a
financial meltdown or the damage depositors] by bank management and regulators inability
to stop this behavior before the fact [read disastrous consequences].
Apropos of both
the above problems, here is a great piece on what the BofA settlement actually
consisted of (medium):
‘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.’
The good news
is that Washington is on vacation. So we
are blessed with the usual summer time lull that insulates us from the
nefarious goings on that typically penalize us when our ruling class is assembled. The bad news is that they are coming back;
and this is an election year. I think it
likely that their time will be largely spent trying to score political points
versus doing the people’s work. That
said, wasting their time scoring political points should be better for us and
the economy than the work they have actually done over the last six years.
The best news
that I think that we can hope for is the absence of bad news.
Goldman’s
assessment of how Washington politics will work after the November election
(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 I noted
above, the minutes from the latest FOMC meeting were released this week and Yellen
gave a keynote speech at Jackson Hole. My
take is that both suggest that monetary tightening could come sooner than many
expected. I consider that relatively great
news---the faster the Fed exists QE and stops interfering with the Market
setting interest rates, the better.
The operative
word in the prior sentence being ‘relatively’.
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. I haven’t
changed that view. Given the enormous
expansion of its balance sheet and the suppression of interest rates for such an
extended period of time, this process should have commenced long ago---even assuming
that I am reading the FOMC/Yellen speech tea leaves correctly.
So I see
inflation in our future---with the caveat noted above, i.e. if the European
and/or the Japanese economies tank, we could see new weakness in our own
economy, in which case, the Fed may luck out on a short term basis. In other words, global malaise could take
some steam out of our economy that would tamp down inflationary pressures. (And
that seems to be what the bond and gold Markets are telling us.) If, and it is
a big if, the Fed continues to tighten (and by the way, it doesn’t have to be a
‘slam on the brakes and come to a screeching halt’ type tightening) in the face
of that a slowing economy, it could escape its self-made trap. But as I said that is a big ‘if’ and it is
much too soon to be making odds on it occurring.
However, as you
know, I am not that worried about the economy, whether there is a slowdown in
global activity or a pick up inflation. To
be clear, I am not saying that these factors will no impact; I am saying that
it is not likely to be particularly severe.
Rather my concern is that the Markets could take it on the chin. Specifically, Fed’s historically
unprecedented expansion of its balance sheet and the artificial pressure it has
maintained on interest rates have led, in my opinion, to the gross mispricing
of assets. A return to a more normal/less
intrusive Fed policy suggests lower prices to me.
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.
Turmoil 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. Indeed, because of the
favorable supply/demand picture, oil prices are almost assuredly higher than
they would be in the absence of all these conflicts. However, all of these issues remain
unresolved. Indeed they continue to
deteriorate---which leaves open the prospect that we still may face higher
prices.
The latest from
Ukraine (medium):
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. Europe remains a trouble
spot. Its economy continues to
deteriorate; and despite the recent ECB move to provide additional liquidity to
the banks, a recession could play merry hell with overly indebted sovereigns
and overly leveraged banks.
In addition,
questions are being raised about which side is being hurt the most by the Russian
sanctions and counter sanctions.
Ultimately, I think that Putin has the hammer because [a] at least at
the moment, his popularity is soaring despite the pain being imposed by
sanctions---so the domestic pressure on him is less than it is on the European
governments and [b] he can turn off the gas if he chooses---which could really
tighten some sphincter muscles.
So far, the EU
has ‘muddled through’. Indeed, that is
our forecast; but potential risks remain from multiple sources.
The economic news
out of Japan has been no better than that from the EU. I am not sure how far economic conditions
will have to deteriorate before the Japanese bureaucrats cry ‘uncle’ and alter
policy. But I assume that the longer it
takes, the greater the impact on the economy and any trading partners.
Update on China
(medium):
Bottom line: the US economy continues to progress despite
little to no help from fiscal and monetary policy. This week’s housing figures reinforce
the recent improvement in the dataflow, while the CPI number could keep the
pressure off the Fed to raise interest rates.
That said, the
economic news from two of our major trading partners (Europe and Japan) keeps
getting worse. Plus Europe is in a pissing contest with Russia over
Ukraine/Crimea related sanctions; and, in my opinion, Putin holds the upper hand. Any serious hiccup in either [or God forbid
both] could have an impact on our own rate of growth. Hence, while I think the US
recession scenario is not a high probability outcome, I am not dismissing it.
Finally, the
political instability in Ukraine and throughout the Middle East is not getting
any better. Certainly, the oil markets
have taken events in stride. But that
aside, I am concerned about the psychological impact of (1) losing a faceoff
between the US and Russian and/or (2) a 9/11 type event executed by ISIS in
retaliation for our stepped up involvement in Iraq.
In sum, the US
economy remains a plus, though the twin risks of inflation and recession are
there. Unfortunately, these are not the
only potentially troublesome headwinds.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
mixed; but both July housing starts and existing home sales were well above
expectations and the NAHB builders confidence index rose,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims fell more than forecast,
(3)
industry: The August Philly Fed manufacturing index
jumped dramatically,
(4)
macroeconomic: July CPI was in line; ex food and energy
it was lower than anticipated; the July leading economic indicators were
stronger than estimated.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17001, S&P 1988) had a good week, despite Friday’s weakness. The Dow is in short (16331-17158) and intermediate
(15132-17158) trading ranges, though clearly it is close to the upper
boundaries of those ranges. It remained
within its long term uptrend (5101-18464) and above its 50 day moving
average.
The S&P
closed within intermediate term (1881-2681) and long term (762-1999) uptrends,
above its 50 day moving average and within a short term trading range
(1814-1991). As you know, it broke above
1991 on Thursday, but gave that back on Friday.
That leaves the short term trading range intact. It is also out of sync with the Dow on its
intermediate term trend.
On the other
hand, the pin action was relatively quiet this week, especially in light of the
slightly more hawkish commentary out of the FOMC minutes and the Yellen/Draghi
speechathon on Friday. That is attribute
to how well this Market is working off its overbought condition.
Volume on Friday
was flat (at an anemic level); breadth was negative. The VIX fell, finishing within short and
intermediate term downtrends and below its 50 day moving average.
The long
Treasury had a see saw week (up, down, up) but remained within its short term
uptrend, intermediate term trading range and above its 50 day moving average.
It continues to be less impressed with the positive trend in the economic stats
and less concerned about rising interest rates or it is more worried
about a geopolitical incident (or both) than the stock boys. As you know, I have been somewhat confounded of
late by the seemingly different interpretation of events by stock and bond
investors---that hasn’t changed.
GLD was up on
Friday (what, it goes up?), bouncing off the lower boundary of that developing
pennant formation---which is a very mild plus.
It remains within a short term trading range, an intermediate term downtrend
and below its 50 day moving average.
Bottom line: the
Averages have done a fair amount of repair work to the technical damage
inflicted two weeks ago and took the FOMC/Yellen/Draghi show surprisingly well. But all is not joy in Mudville. Both indices have still not managed to break
above their former highs. Indeed, the
S&P broke above its former high on Thursday only to be slapped back down of
Friday. And the indices are out of sync
on the intermediate term uptrends.
Further, in this latest rebound, the numerous divergences that have
emerged did not show signs of correcting.
Finally, bonds and gold aren’t acting like the economy is improving and
inflation is a risk.
This all sounds
like a topping process. But the ‘buy the
dippers’ just haven’t given up. And
until they do, any sell off will be short lived. It does remain to be seen whether the
Averages can break (and confirm) (1) their former all-time highs. I think that they will and (2) the upper boundaries
of their long term uptrends. That is a
bigger nut to crack and at the moment, my bet is that they won’t make it.
Our strategy remains to do nothing. Although it is not too late to Sell stocks
that are near or at their Sell Half Range or whose underlying company’s
fundamentals have deteriorated.
I am staying
with my bond positions in our new ETF Portfolio and have not Sold the trading
position in HDGE.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17001)
finished this week about 44.0% above Fair Value (11806) while the S&P (1988)
closed 35.6% 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.
The US economic
dataflow continues to point to a sluggishly growing economy. Indeed over the last several weeks, it has
relieved some anxiety about the potential onset of a recession. On the other hand, the stats out of Europe
and Japan have been abysmal. Plus both
are more indebted and their banks more leveraged than our own. So I think that
it makes sense to be concerned that economic malaise within two of the US’s
biggest trading partners could impact our own economy and securities markets if
conditions continue to worsen.
Meanwhile, back
at the Fed, the tone became slightly more hawkish this week. That has a positive bias to it (for me), if
it will only quit fiddle fuckin’ around and get on with the show (raising
interest rates). I don’t think that this
seeming change in attitude lessens the risk of inflation; but it may lessen the
ultimate magnitude of inflation---if these guys (and gal) really mean it. In any case, I don’t think what happens to
the economy is the key consequence to a more firm monetary policy. The key consequence is, in my opinion, the
unwinding of artificially set asset pricing---which is to say, prices are likely
to decline.
I continue to
believe that the faceoff in Ukraine has reached the point that it is a
lose/lose game for the US. It makes no
sense to escalate; and even on the outside chance that it occurred, there would
be no winners. That leaves
negotiations/compromise/blah, blah, blah in which Putin is going to win because
he holds many of the important cards and he has brass balls. The only question is, how much will the US be
embarrassed by the resolution? If a
lot, Markets aren’t apt to like it.
The other big
question, is how logistically sophisticated is ISIS? Now that Obama has decided to reverse the
policy that He spent the first six years of His presidency condemning, what
kind of hornet’s nest has He stirred up in Iraq? Specifically, has the US engaged an enemy
with the will power and resources to launch another attack on the US or its
citizens overseas? I have no clue what
the answer is; but I would really like somebody to give me a hint.
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 and/or 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.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 8/31/14 11806 1465
Close this week 17001
1988
Over Valuation vs. 8/31 Close
5% overvalued 12396 1538
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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