The Closing Bell
9/20//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 5148-18484
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1944-2145
Intermediate
Term Uptrend 1917-2717
Long Term Uptrend 771-2020
2013 Year End Fair Value 1430-1450
2014 Year End Fair Value
1470-1490
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 45%
High
Yield Portfolio 53%
Aggressive
Growth Portfolio 47%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s data releases by volume were positive but two primary indicators were
negative: positives---weekly mortgage and purchase applications, weekly jobless
claims, the NY Fed manufacturing index, August CPI and the second quarter US
trade deficit; negatives---August housing starts, August industrial production
and August leading economic indicators; neutral---weekly retail sales, the
Philly Fed manufacturing index and August PPI.
August housing
starts and industrial production are this week’s stand out numbers. Both are primary indicators and both suggest
a potential slowing in the US economy---as does the latest reading of the
leading economic indicators. Certainly,
it is much too early to tell. But the
big question is, is the slowdown in the global economy beginning to impact our
own? Clearly it reinforces my recent reordering
of risks to the economy---with global recession now numero uno. Stay tuned.
Of course, all
the above was overshadowed by the FOMC meeting, the release of an updated Fed policy
statement and the subsequent Yellen news conference. I covered this all in Wednesday’s and
Thursday’s Morning Calls; but the bottom line is that the stock boys
interpreted the statement/news conference as dovish while the bond guys saw
them as hawkish---which leaves me confused.
It also emphasizes that the Fed policy remains a significant risk not
just to the economy in that it may botch the transition to normalized policy but
also to the Market in that the uncertainty created by the obtuseness of its
communication could by itself spawn a huge risk-off move.
Quantitative
futility (short):
What QEIII
bought us (medium)?
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
The
negatives:
(1) a
vulnerable global banking system. Surprise, surprise. We actually made it a week without learning
of another bankster misdeed.
That doesn’t mean
that there are no problems (medium):
http://www.nakedcapitalism.com/2014/09/accident-waiting-happen-1-trillion-leveraged-loan-market.html
‘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 has
already come and gone, staying just long enough to pass a continuing budget
resolution and approve Obama’s new war (oh, wait a minute, we aren’t supposed
to use that word) policy---which if you are like me, you now feel ever so much
more confident in the likelihood of our success.
The operative
word above is ‘gone’ meaning that when the ruling class is out of town, they
can’t fuck with us.
(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.
Cognitive
dissonance reigned supreme this week.
(1) the Japanese reported that August exports continued to decline
making a further mockery of Abenomics’ QE to infinity---as if it needed something
else to make the point. (2) the ECB
tried the first installment of its new liquidity injection funding facility and it was a total bust---the banks
simply didn’t want the money irrespective of its give-away price, (3) China
injected funds into its financial system---which initially had investors
getting jiggy with it. But then it
stated this action was limited and should not be interpreted as the start of
any loosening in monetary policy, and (4) last but certainly not least, our own
Fed issued a new policy statement, which to date has had the bond and stock
markets going in opposite directions.
Ultimately, this whole dovish versus hawkish dichotomy will be
resolved. Based on historical
performance, I think that the bond guys will prevail. But that doesn’t mean that they will.
The point of
this discussion is that monetary policy among the major economic powers is
tuned to expansion but it is not having the impacted expected by the
bureaucrats implementing it. As you
know, this is hardly a surprise to me; and frankly, it shouldn’t be a surprise
to anyone with a reading proficiency above the third grade. The question is, have we reached the point
where the global markets have had enough of central bank pumping and dumping
and as a result, they will go from responding to policy moves to forcing them?
Whether or not
that happens, the above does suggest that at least some of the markets are no
longer buying QEInfinity.
(3)
rising oil prices.
Unless the West does something really stupid, it looks to me like it is
all over but the shouting in Ukraine.
Putin has Crimea and a land bridge there to. To be sure, Ukraine is making noises of joining
NATO; but that is more than a year away---giving Putin plenty of time to thwart
that move.
On the other
hand, the action is picking up in Syria/Iraq/ISIS. Gosh only knows how this mess will work out;
but given the lack of success of our foreign policy to date, I am not holding
my breath for a positive ending.
That said, the
price of oil has only gone down for the last month. 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.
So barring a dramatic development, I would judge this risk as ever
diminishing in magnitude.
(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; and the central banks are working feverously
to inject additional liquidity into their financial systems. Unfortunately, as I noted above, those
efforts to date have come to naught; and I see no reason why that should
change.
The questions are,
are these central banks at the end of their policy rope? And if they are, how
long can the European and Japanese economies hold on before an accelerated
slide into recession begins? And if that occurs, what happens to all those massively indebted sovereigns and
overleveraged banks?
The
Japanification of central banks (a bit long and a bit in the weeds, but a very
good read):
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.
Certainly, the recent poor export data out of Japan bears witness to the
lack of success of implementing competitive devaluation (devaluing the yen via
excessing money printing). 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. And unfortunately, we may be
seeing the first signs of that weakness effecting our own economy.
Bottom line: the US economy continues to progress though
this week’s housing and industrial production numbers are concerning. Of course, it is too early to tell, but the
worry is that they presage the impact of a slowing global economy on the US.
The economic
news from Japan, China and Europe, three of our major trading partners, keeps
getting worse. True, the central banks of all these entities have instituted
easier monetary policies; but history is repeating itself and to date these
policies are having little effect. Although
as in the US, speculators are loving the cheap money.
The fat lady
appears about to sing in standoff between the EU and Russia over Ukraine. Putin has Crimea and his land bridge to
it. On the other hand, Ukraine is
pushing to join NATO to which Russia very much objects. So this story is not quite over. But barring something really stupid out of the
EU and US ruling class, the danger of some geopolitical nightmare seems to be
subsiding.
ISIS and Obama
are poking each other in the eye. By all
rights, severely disabling this group ought to be a walk in the park. But with a pacifist president who is being
pushed by His party to look tough ahead of the elections and a lack of support
from an imaginary ‘coalition of the willing’, the outcome of this conflict is
anything but assured. Truth be told, US
policy has done nothing but make the Middle East more volatile and uncertain
since we invaded Iraq. Now with a weak
and reluctant president, stability seems out of the question. I have no idea how this morality play ends;
but I fear it won’t be good for the US.
Stockman on
Obama’s ISIS policy (long but a good read):
In sum, the US
economy remains a plus, assuming this week’s housing and industrial production
numbers are outliers. The rest of the world is not in such great shape and my
main concern is that its growth rate slips further and starts to impact the US
economy. The geopolitical risk from
Ukraine is declining while the Middle East is heating up.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up; August housing starts were extremely disappointing,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims fell more than forecast,
(3)
industry: August industrial production was less than
anticipated; the September NY Fed manufacturing index was much stronger than
expected while the Philly Fed index was in line,
(4)
macroeconomic: August leading economic indicators rose
less than estimated; both the headline and ex food and energy components of
August PPI were in line while those of August CPI were well below forecasts;
the second quarter US trade deficit was lower than anticipated.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17279, S&P 2010) had a mixed day on Friday (Dow up, S&P
down) but a good overall week. The Dow broke
above the upper boundaries of its short (16331-17158) and intermediate
(15132-17158) term trading ranges. Under
our time and distance discipline, if it remains above 17158 at the close Monday,
the short term trend will re-set to up.
If it does so at the close on Tuesday, the intermediate term trend will
re-set to up. It finished within its
long term uptrend (5148-18484) and above its 50 day moving average.
The S&P
closed within uptrends across all timeframes: short term (1944-2145, intermediate
term (1917-2717) and long term (771-2020).
It is also above its 50 day moving average.
As you know,
there were conflicting interpretations of the FOMC/Yellen statement; but
clearly the Averages believed them to be dovish---which pushed prices higher
and provided the strength for the Dow to break and hold above 17158. True,
there remains some time left in our trading discipline before DJIA re-sets its
short and intermediate term trends. But
I assuming that those re-sets will occur.
That means that the upper boundaries of the indices long term trading
range are the next upside target for them to aim at.
If the stock
market’s interpretation of a dovish Fed is correct, then the Averages will also
surely challenge those levels; and the likelihood of confirming a break above them
has become higher. That said, the
further stocks advance, the more questionable valuations become and the fewer
true believers will be left to buy. So
even if those long term uptrends are challenged, I believe the pace of price
increases will become more labored.
Volume on Friday
was through the roof---largely a function of quadruple witching (option and
futures expiration); but breadth was abysmal.
The VIX was up fractionally, closing within short and intermediate term
downtrends and below its 50 day moving average.
The long
Treasury had a strong day on Friday, rebounding sufficiently to mark the 112.7
level as the lower boundary of a newly re-set trading range. As you know, TLT along with bonds in general
had a rough week primarily as a function of a more hawkish interpretation of
the FOMC/Yellen statements. I thought it
curious that bonds staged a nice recovery on Friday while the S&P and small
cap averages were down.
That said,
bonds, stocks and commodities all experienced volatility this week and not
always in a consistent manner. That has
created some confusion for me in that I am not sure what kind of scenario they
might individually be discounting. Of
course, it may be nothing more complicated than that investors across the board
are as confused as I am and their trading reflects it.
GLD was down on
Friday, remaining stuck within short and intermediate term downtrends and below
its 50 day moving average. It continues
to be one of the ugliest charts around.
Bottom line: on
the surface, the Averages are telling us that it is clear sailing for as far as
the eye can see. But not only are the
internal divergences continuing to widen, but now bonds, commodities and real
estate (REIT’s) are behaving in a way inconsistent with a dovish Fed, Bank of
Japan, ECB and Bank of China.
I could propose
all kinds of possible scenarios that might explain this behavior but it would
be sheer speculation. So I will stick
with the easiest: I don’t know; I am not sure many investors out there have a
clue; hence, I wait for clarity---happy in the knowledge that our Portfolios
have lots of firepower if things go awry.
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 (17279)
finished this week about 46.0% above Fair Value (11829) while the S&P (2010)
closed 36.9% 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---although this
week’s housing, industrial production and leading economic indicators reports were
very disappointing and call that scenario into question. As I always say, one week does not a trend
make; but it can put you on alert.
Furthermore, the
stats from overseas are not encouraging.
Japan just reduced its economic growth forecast. The ECB’s first attempt at pumping money into
the EU financial system was a bust and while the Bank of China added liquidity,
it cautioned that it remained determined to wring speculation out of its real
estate market.
As you know, I recently
upgraded global recession/stagnation to the number one risk to our
economy. This week’s events only
reinforces my conviction. Indeed, I am
concerned that the aforementioned poor US economic data could be the first sign
that foreign economic problems are starting to impinge on US growth. To be clear, this is a worry not a
forecast. But it clearly must be
watched.
Meanwhile, the
Fed managed to confuse everyone this week.
Certainly, equity investors weren’t confused. They interpreted the FOMC and Yellen comments
bullishly and pushed the Dow through the upper boundaries of its short and intermediate
term trading ranges while at the same time making a new all-time high. However, bond, commodities and real estate
(REIT’s) investors were not nearly as sanguine as prices in all declined on the
premise that the Fed had turned more hawkish.
Then on Friday, things only got even murkier when bonds rallied and the
S&P and small caps declined
Check out the
recent performance of the commodity index (short):
Now the charts
of bonds, the Russell and the transports (short):
In short as of
Friday, I am clueless as to what investors in any of the aforementioned markets
are discounting. Of course, I have been
here before; and I do know that all will
be revealed in due course. I am just
glad that our Portfolios are not leveraged or overly exposed to any Market or
market segment and have plenty of cash.
Just to address
the geopolitical risks for a second. The
crisis in Ukraine seems to be fading fast as Putin has gotten most of what he
wanted. There is still the matter of
Ukraine being too cozy with the West; so the fat lady hasn’t sung yet. But barring the West getting far more
aggressive than it currently is, I suspect that won’t be an issue a year from
now.
On the other
hand, nothing good is likely to happen in the Middle East as the US lurches
from one inane policy adjustment to another.
My hope is that the players are too busy killing each other to have the
time to come after the US. Think 9/11 or worse.
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 every week). 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 9/30/14 11829 1468
Close this week 17279
2010
Over Valuation vs. 9/30 Close
5% overvalued 12420 1541
10%
overvalued 13011 1614
15%
overvalued 13603 1688
20%
overvalued 14194 1761
25%
overvalued 14786 1835
30%
overvalued 15377 1908
35%
overvalued 15969 1981
40%
overvalued 16560 2055
45%overvalued 17152 2128
50%
overvalued 17743 2202
Under Valuation vs. 9/30 Close
5%
undervalued 11237 1394
10%undervalued 10646
1321
15%undervalued 10054 1247
* 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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