Investing for Survival: The Closing Bell

The Closing Bell

9/6//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%

2015 estimates

Real Growth in Gross Domestic Product +2.0-+3.0

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 Uptrend 1936-2137

Intermediate Term Uptrend 1900-2700

Long Term Uptrend 762-2014

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 were a tad more positive than negative: positives---August vehicle sales, the August Markit manufacturing and services indices, the August ISM manufacturing and nonmanufacturing indices and the July trade deficit; negatives---weekly jobless claims, the August ADP private payroll report, August nonfarm payrolls, July factory orders and revised first quarter nonfarm productivity and unit labor costs; neutral---weekly mortgage and purchase applications, weekly retail sales and second quarter nonfarm productivity and unit labor costs.

Friday’s surprisingly anemic August nonfarm payroll number stands out as the most noteworthy US stat of the week. It seems to have caught most pundits flatfooted and clearly brings to a halt the string of months with 200,000+ job growth. While concerning, I would be a lot more worried if (1) August weren’t traditionally the most volatile month for this datapoint and, hence, frequently revised and (2) it was part of a pattern. At the moment, it is simply an isolated stat. So we need to take this number with caution until we get some additional confirming data.

http://scottgrannis.blogspot.com/2014/09/the-august-jobs-report-changes-nothing.html

This week’s primary economic news came out of the Bank of Japan and the ECB. Both eased monetary policy---the BOJ adding to its QE while the ECB lowered three of its funding rates and commenced its own version of QE. I am not going to dwell too long on what I think of these moves because I have covered this in our Morning Calls. But in summary:

(1) Japan’s economy is a mess partly as a result of its already failed QE. Why doing more of the same and expecting different results will improve the situation is a step too far in my logic system,

(2) the EU economy is also in shambles largely as a result of fiscal policies that have led to deeply indebted sovereigns and an over leveraged banking system. But those causal fiscal policies haven’t changed; and pushing more money into the financial system whatever the price won’t help. Adding cheap liquidity doesn’t pay down debt for either the banks or the sovereigns. It also is little incentive for productive lending---money in the EU is already cheap; if corporations wanted to borrow to finance new projects, they would already have done so. All this latest action does is provide cheap money that allows the sovereigns to go deeper in debt and the banks to acquire more leverage.

http://www.nakedcapitalism.com/2014/09/ecb-enabler-doubles-failed-monetary-policies.html must read

More on why Draghi’s plan won’t work (medium)
http://www.zerohedge.com/news/2014-09-05/why-draghis-abs-stimulus-plan-wont-help-europes-economy

(3) but never fear, the fast money will love it because with the Fed winding down QE, it will now have a new source of funding.

While we are on the subject of Japan and Europe, the economic data from these entities did nothing to improve this week. They are both teetering on recession. While there has been little noticeable impact on the US economy to date, I have difficulty believing that these three economies have completely decoupled. As a result, I am re-ordering my thinking on the risks facing the US economy, to wit, I now believe that the economic problems facing Japan and Europe (and perhaps China) now pose the greatest risk to our outlook while Fed policy goes to number two.

I want to emphasize that Fed policy (botching the transition to a normalized monetary policy) is still a significant risk. But that risk would be mitigated somewhat, if the global economy slows down because the timing of any interest rate increase by the Fed would become less important---that is, if the global economy slows, the need for tighter money lessens. So it is possible that any increase in rates could be postponed with little affect---depending on the magnitude of slowdown. In fact, the bigger potential problem that I see in that scenario is if the Fed fails to account properly for a coming recession, raises interest rates and exacerbates the impact on the US.

Finally, you may have noted above in the Statistical section that I have posted an initial 2015 forecast. It basically reflects continued sluggish US growth, no increased upward pressure on inflation due to the growing risk of an international slowdown and some improvement in corporate profits. I am going to tag this forecast as tentative until we get more information on the economies in Japan and Europe.

More evidence that the growth rate of this recovery is not going to pick up (medium):

http://www.advisorperspectives.com/dshort/guest/Lance-Roberts-140903-Calling-It-Like-It-Is.php

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, the weakening in the global economic outlook, 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 is awash in cheap, clean burning natural gas.... In addition to making home heating more affordable, low cost, abundant energy serves to draw those manufacturers back to the US who are facing rising foreign labor costs and relying on energy resources that carry negative political risks.

http://www.aei-ideas.org/2014/09/natural-gas-production-in-the-utica-shale-has-increased-almost-7x-in-2-years-and-its-potential-just-got-even-bigger/

The negatives:

(1) a vulnerable global banking system. We almost made it a whole week without learning of another bankster misdeed. Well, yesterday a judge ruled that most of the [too big to fail] banks could be sued for price rigging the credit default swaps market.

http://www.reuters.com/article/2014/09/04/us-creditdefaultswaps-lawsuit-idUSKBN0GZ2IY20140904

On a different matter in an attempt to further improve the US banking system’s ability to withstand another financial crisis, regulators are issuing a new capital requirement called a ‘liquidity coverage ratio’ which forces banks to have sufficient cash on hand to withstand a run on their deposits. Sounds like a great idea and it does have its merits. Below is an analysis that reveals the weakness in the plan. The results will likely not be as bad as portrayed in the article but likewise won’t live up to its billing. http://www.zerohedge.com/news/2014-09-03/printer-and-prayer-three-problems-fed-liquidity-coverage-ratio-plan

‘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.’

Congress returns next week and the pre-election posturing will begin in earnest. I doubt little of substance will occur between now and year end. That, of course, is the good news. Wasting time scoring political points should be better for us and the economy than the work congress has actually done over the last six years. Nevertheless, the rhetoric could get hysterical at some point which may give Mr. Market some heartburn.

(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, while I have very little good to say about Fed policy, it may be taking a back seat to global economic activity. Not that Fed policy hasn’t built in the potential for the unleashing of inflationary tensions. Indeed, it might be easy to assume that with Japan and the ECB picking up the QE mantle, those price pressure will only be exacerbated.

However, as you know, I also have nothing positive to say on the latest moves by the BOJ and ECB. Indeed, I think that they will do nothing to alter the recessionary forces already at work in Japan, Europe and China. So, I am becoming increasingly convinced that those forces will keep a lid on any inflationary impulses that might come from tight production or labor conditions.

http://www.zerohedge.com/news/2014-09-05/monetary-stimulus-obsession-it-will-end-disaster

All my pissing and moaning about the Fed, BOJ and ECB policies aside, I have said all along that I thought the primary risk that QE (s) posed was to the markets rather than to the economy. With the new actions by Japan and the ECB, I believe that conclusion has just been squared. As I noted above, I think that the easier money from the Bank of Japan and the ECB will primary influence the securities markets [carry trade] to the exclusion of their economies. Hence, we could see some commodity speculation, higher interest rates as well as another extended run in the global stock markets in the short run. But in the end those policies will simply misprice assets to a greater extent than if the Fed had done this all by its lonesome.

And speaking of QE impacting the markets, look at the latest CME financial statement showing central banks as customers (short):

http://www.zerohedge.com/news/2014-09-05/whats-point-hiding-it-any-longer

(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 remains 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.

(4) economic difficulties, overly indebted sovereigns and overleveraged banks in Europe and around the globe. The incoming economic data from Europe and Japan remain weak. This week’s central bank moves are designed to correct that situation and initiate growth. However, as I have observed ad nausea, prior similar steps have proven fruitless.

Not helping matters in Europe is the ongoing pissing contest over who can impose the most onerous sanctions on whom. Despite the observable impact of those sanctions on Russia, [a] Putin’s popularity ratings have never been higher, [b] even without those ratings, he exercises greater control over his ‘electorate’ than any government in the West, [c] Russia still has the energy card which will become increasingly important the closer we get to first snow and [d] Putin has a will that is not matched by any western leader or combination thereof. Hence, I see Russia as the ultimate winner in this faceoff. The only questions are how much pain is Europe willing to endure before it cries ‘uncle’ and how will that pain effect future economic activity?

This is a good analysis of Putin’s strategy and is bit more dovish than my own (medium):

http://www.zerohedge.com/news/2014-09-04/putins-ukraine-strategy

The economic news out of Japan has been no better than that from the EU; and the government’s attempts to correct that problem have been even more feeble than the Euros. I am not sure how long the Japanese workingman will put up with this bullshit before they kick the government out. But I assume that the longer it takes, the greater the impact on the economy and any trading partners.

http://www.zerohedge.com/news/2014-09-05/japans-money-illusion-will-fail-goldman-warns

Bottom line, I have no reason to assume that the results from the latest BOJ/ECB QE will be any different from prior failed attempts. On the other hand, more QE and lower interest rates can impact the US economy by driving the yen and euro down versus the dollar in an attempt to improve their own economies (raising import costs and lowering export prices) at the expense of our own. Of course, this could also serve as a double whammy to their own economies if the improvement in exports isn’t more than offset by the decline in imports. I mention this because that is exactly what is occurring in Japan. Which begs the question, what the fuck are these guys thinking about?

Hence, I see continued deterioration rather than improvement in global economic activity; and that belief is what drives me to the conclusion that global recession is the number one risk to our economy.

To be sure so far, the EU/Japan and the rest of the world have ‘muddled through’ with little impact on our economic progress. Indeed, that is our forecast; but as I noted, it is now the biggest risk in that outlook.

Bottom line: the US economy continues to progress despite little to no help from fiscal and monetary policy. This week’s dataflow continues to support our forecast.

On the other hand, the economic news from two of our major trading partners (Europe and Japan) keeps getting worse. True, the central banks of both entities instituted easier monetary policies this week in an effort to turn their economies around. Given the lack of imagination of those policies, specifically that their entire substance was to expand measures that have already proven unsuccessful, I don’t think much will be accomplished in terms of economic improvement. Although I am sure it made the carry trade happy.

Further, the geopolitical standoff between the EU and Russia over Ukraine will, in my opinion, only make conditions there worse and will likely continue until Putin gets what he wants. Yesterday, Russia and Ukraine announced yet another cease fire and the globe seemed to breathe a sigh of relief---like this cease fire has any better chance of holding than all the prior ones. I reiterate my view: (1) Putin has stated in no uncertain terms that the greatest tragedy of the twentieth century was the dissolution of the Soviet Union, (2) very action he has taken supports that view, (3) so I have to assume that every action that he will take will support that view, (4) which means that there will only be a settlement in Ukraine when Putin has what he wants---a land bridge tying Russia to the Crimea and a politically neutral Ukraine and (5) I see no political power out there with the courage and will to prevent (4) from occurring.

Finally, the political instability in the Middle East is not getting any better. Obama fiddles while Iraq burns; and ISIS has now demonstrated that is just as willing to take the battle to us as we are to them. We may have the planes; they have the martyrs. Obama was out trying to sound tough following the NATO meeting; but we all know that that was just a warm up for His golf game. And lest we forget, September 11 is next week.

In sum, the US economy remains a plus. Geopolitical/economic problems are becoming much more potentially troublesome headwinds.

This week’s data:

(1) housing: weekly mortgage and purchase applications were mixed; July construction spending was strong,

(2) consumer: weekly retail sales were mixed; weekly jobless claims rose more than forecast, while the August ADP private payrolls report was a disappointment; August nonfarm payrolls were well below anticipated levels; August vehicle sales were above estimates,

(3) industry: the August Markit manufacturing index was slightly ahead of expectations as was its services index, while the August ISM manufacturing index was well ahead of forecasts as was its nonmanufacturing index; July factory orders were less than anticipated, ex transportation they were negative,

(4) macroeconomic: the last Beige Book recorded economic activity in line with estimates; the July trade deficit was less than expected; second quarter nonfarm productivity and unit labor costs came in near forecasts, but the first quarter numbers were revised dramatically to the negative.

The Market-Disciplined Investing

Technical

The indices (DJIA 17137, S&P 2007) had a good week. 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 uptrends across all timeframes: short term (1936-2137, intermediate term (1900-2700) and long term (762-2014). It is also above its 50 day moving average.

Clearly, both of the Averages are near crucial levels---the Dow to the upper boundaries of its short and intermediate term trading ranges; the S&P to the upper boundary of its long term uptrend. However, they remain out of sync and the Dow has already attacked 17158 twice unsuccessfully. Nonetheless, it seems almost inevitable that the Averages will continue to at least challenge these levels; it appears likely to me that some will be penetrated; I think that there are, at best, even odds that all those breaks would all be confirmed; but I have serious doubts that any break will be of any magnitude or length.

Volume on Friday inched higher; breadth bounced back. The VIX fell, finishing within short and intermediate term downtrends and below its 50 day moving average. And if you have been looking at the links that I posted this week, you know that the number of divergences continue to increase.

The long Treasury had a rough week largely as a result of either actions by the BOJ and ECB to stimulate their respective economies---investor expectations being that those moves will be successful and push interest rates higher---or the assumed lessening of tensions in Ukraine. Nonetheless, it held its trends: a short term uptrend, an intermediate term trading range and above its 50 day moving average.

GLD was up on Friday but remains stuck within a short term trading range, an intermediate term downtrend and below its 50 day moving average.

Bottom line: the Averages continue to repair work to the technical damage inflicted last month; and given the new dose of QE from Japan and the EU plus the supposed lessening in tensions in Ukraine, that trend could continue at least for a short time.

In addition, the ‘buy the dippers’ just keep showing up when they are needed. And until they don’t, any sell off will be short lived. It does remain to be seen whether (1) the Dow can break [and confirm] its former all-time high---I think that it will and (2) the S&P can break [and confirm] the upper boundary of its long term uptrend. That is a bigger nut to crack and at the moment, my bet is that it only has even odds at the best of doing so.

Finally---and I know that I have been crawfishing a bit on this point---there is some chance that both indices will bust through the upper boundaries of their long term uptrends. However, give the level of extreme valuation, I don’t think that those breaks will be of serious length or magnitude.

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.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (17137) finished this week about 44.8% above Fair Value (11829) while the S&P (2007) closed 36.7% overvalued (1468). 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---this week’s stats epitomizing that scenario with strong ISM numbers and an unexpectedly weak employment figure. This remains the biggest plus for stock prices.

On the other hand, the stats out of Europe and Japan have been abysmal. This week’s ‘all in’ monetary policy moves notwithstanding, I don’t think that the numbers are apt to improve because (1) the Japanese are already ‘all in’ and its policies haven’t worked and (2) the EU’s problem is its sovereigns that are too indebted and its banks that are too leveraged. More QE and lower rates aren’t going to resolve those issues.

In any case, the global economic slowdown is now my number one risk to our economy and the fallout from it whether lower corporate profits, higher interest rates or an unwind in the carry trade is the number one risk to our Market.

Meanwhile, back at the Fed, its equation for when and how fast to raise interest rates might change if conditions in Europe and Japan continue to erode. That is, if the probability of an economic slowdown in the US is now higher due to international problems, then the timing and magnitude of any tightening may be adjusted.

Not that the Fed should back off the goal of reducing bank reserves and allowing interest rates to be priced by Market forces. However, with its strong inclination to overrule Market forces, the Fed runs the risk of pushing interest rates too high at a time when Market forces would be moving in the other way due to growing recessionary forces. Whatever it does, slowdown in the global economy could take the near term pressure off the Fed to ‘get it right’; hence leading me to reduce this risk to number two on the Market Risk Hit Parade.

‘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.’

On Friday, we received news of a cease fire between Russian and Ukraine along with Obama’s announcement of a ‘new coalition’ to combat ISIS.

(1) there hasn’t been a cease fire yet in the Ukraine standoff that has held and, in my opinion, this one won’t either unless Putin gets what he wants.

(2) to date, all those new so called participants in the anti-ISIS coalition haven’t had the cojones to combat radical Islam in their own countries. There are entire swaths in England, France, the Netherlands, etc. where the local police won’t even go to enforce the laws of their own countries. How tough do you think that those countries are going to be when an ISIS-friendly enemy force [a] already occupies a part of their land and [b] can be easily be reinforced with ISIS fighters carrying their country’s passports?

In my opinion, nothing is going to change until somebody in the West grows a set a balls or until the unwashed masses comprehend the existential threat being posed by either or both a rejuvenated Russian empire and a radical ideology dedicated to the fall of Western civilization---which is unlikely to happen until that threat becomes real. Think 9/11 or worse---and don’t forget 9/11 is this coming week.

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 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.

Saturday, September 6, 2014

The Closing Bell

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