The Closing Bell
9/27/14
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 1955-2146
Intermediate
Term Uptrend 1922-2722
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 47%
High
Yield Portfolio 53%
Aggressive
Growth Portfolio 49%
Economics/Politics
The
economy is a modest positive for Your Money. This
week’s economic data was generally weak: positives---August new home sales,
weekly jobless claims, the University of Michigan’s final September index of consumer
sentiment and the September Richmond Fed manufacturing index; negatives---weekly
mortgage and purchase applications, August existing home sales, August durable
goods orders, the Kansas City Fed manufacturing index, the August Chicago national
activity index and the September Markit manufacturing and services PMI’s; neutral---weekly
retail sales.
August new and
existing home sales along with August durable goods orders were the important
numbers this week. The good news is that
we finally received an upbeat primary indicator (August new home sales). The bad news is that (1) there were two
negative primary indicators (August existing home sales and durable goods
orders) which does nothing to assuage my concerns about the US economy starting
to be impacted by the weak global economy and (2) existing home sales are
roughly ten times the size of new home sales.
So even our positive indicator was the least important of the three.
In short, while
our outlook remains the same, the primary risk to it also is unchanged.
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. We knew that the banksters couldn’t stay out
of the spotlight for too long. This
week, Barclay’s was fined for failing to segregate client funds [ala MF Global]
http://www.zerohedge.com/news/2014-09-22/barclays-fined-de-minimus-60-million-corzining-client-funds
An absolutely
must read article on major US bank exposure to the derivative markets (medium):
And another
must read article about the relationship between Wall Street and the Fed as
disclosed by 47 hours of secretly taped conversations (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.’
Out for
elections.
(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.
Global central bank
policy continued as a lead headline this week.
[a] Draghi made another of his ‘whatever is necessary’ comments in
response to a question about the lousy EU economy {which by the way, continues
lousy according to the data} on the same day that the Germans made another of
their ‘over our dead bodies’ comments. In
sum, the economy deteriorates and the ruling class flaps its gums. [b] the Chinese premier commented that he
would likely replace the head of the Bank of China, who happens to be a monetary
hawk. The implication here being that
China is about to rejoin the League of QEInfinity, and [c] we received yet
another signal that the Japanese are living in some parallel universe---in a
form of a report noting the increase in equity holdings of the Bank of
Japan.
The problem, of
course, is that [a] none of this QE bullshit is having an impact on any of the
respective economies and [b] what effect that it does have is on asset prices
which keep getting more and more overvalued.
How long the Markets or the central banks themselves will remain complicit
in these incongruous results is anyone’s guess.
Certainly, I thought that it would end long ago. Nevertheless, unless the outcomes change, at
some point asset prices will become so disconnected to the underlying economics
that either policy or price adjustments or both are inevitable.
(3)
rising oil prices. Last week, it appeared as though Ukraine was
fading as a geopolitical flashpoint. This
week, Russia decided to let the West know that it was not to be trifled with: [a]
in response to Italy’s seizure of some homes of one of Putin’s buddies, Russia
is threatening to freeze foreign assets, and [b] in response to the EU
re-selling Russian gas to Ukraine, it is threatening to cut off gas supplies to
the EU. Clearly, this crisis is not as
close to over as I had thought, although I do believe that there is a diminishing
likelihood of a major military confrontation.
Syria/Iraq/ISIS
just turned very hot. So far, this conflict
has had little impact oil prices because everyone wants the revenues therefrom
so little damage has been inflicted on production or refining facilities. However, we are now bombing ISIS refining
resources and that may bring in kind retaliation---though I am still unclear on
exactly how capable ISIS is of doing so.
In short, the
risk here seems to be more geopolitical than economic [oil]. Of course, in a war zone, anything can happen
so there remains some probability of higher oil prices that could negatively
impact global economic growth.
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The ECB and BOJ continue to
pump up the volume; their respective economies continue to be
unresponsive. Even worse, the one hold
out among our major trading partners [China] now appears to be giving up on its
attempt to curb speculation in its real estate market in order to join this
crowd of losers. I can only repeat the
question that I posed in last week’s Closing Bell---what the fuck are these
guys thinking about?
I shake my head
and conclude that in the absence of some earthshaking development that alters
the current dynamics of QEInfinity, 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 affecting our own economy.
Another must read from David
Stockman (medium):
Bottom line: the US economy continues to progress though with
each passing week’s dataflow, that proposition is being increasingly called
into question. It is still too early to
tell, but the worry is that these incoming stats 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, this week the Chinese appear ready to join the easy money
crowd. Why, I haven’t a clue since
QEInfinity has to date done little to improve their economies.
Semantics aside,
the US and ISIS are now at war. ‘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.’
In sum, the US
economy remains a plus, though less so with each passing week. 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.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
down; August existing home sales fell while new home sales soared,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims fell less more than forecast,
the University of Michigan’s final September index of consumer sentiment was in
line,
(3)
industry: August durable goods orders were less than
anticipated. the August Chicago national activity index was much weaker than
expected; both the September Markit manufacturing and services PMI’s were lower
than estimates; the September Richmond Fed manufacturing index was ahead of
forecasts while the Kansas City Fed index lagged,
(4)
macroeconomic: none.
The Market-Disciplined Investing
Technical
If
you feel like you are on the Texas Giant roller coaster, join the crowd. The indices (DJIA 17113, S&P 1982) rebounded
sharply on Friday after the big down Thursday.
For all the recent volatility around the upper boundary of the Dow’s
short and intermediate term trading ranges, in the end, nothing changed
technically. It closed within short
(16332-17158) and intermediate (15132-17158) term trading ranges, within its
long term uptrend (5148-18484) and bounced off its 50 day moving average.
The S&P
closed within uptrends across all timeframes: short term (1955-2146, intermediate
term (1922-2722) and long term (771-2020).
It is also above its 50 day moving average after having broken below it
on Thursday.
Volume fell on
Friday; but breadth roared back. The VIX
declined, closing within a very short term uptrend and above its 50 day moving average
but within short and intermediate term downtrends.
The long
Treasury sold off on Friday, but that was more a function of Bill Gross leaving
Pimco (fears of some portfolio liquidation) than any macroeconomic
factors. It remained within short and intermediate
term trading ranges and above its 50 day moving average.
GLD was down on
Friday (what’s new), remaining stuck within very short, short and intermediate
term downtrends and below its 50 day moving average. It is nearing the lower boundary of its long
term trading range. It is almost sure to
challenge that boundary, though breaking a long term trend line is a difficult
process.
Bottom line: the
confusion and volatility that marked the bond, commodities and real estate
(REIT’s) markets last week leaked over into the stock market this week. Moreover, many of those internal divergences
that I keep harping on just keep getting more disparate.
I have said for
the last three weeks that the above were manifestations of something going on
beneath surface of the Markets. I don’t
know if it is the realization that (1) the US could be headed for a recession,
(2) investors have finally grasped that QE hasn’t, isn’t and likely will not
work, (3) the probability is rising substantially of an explosion in one of the
several geopolitical hotspots, or (4) some combination thereof.
I don’t have the
answer as to what it is but I am very happy that our Portfolios are not part of
the stats depicting margin debt, net free credit or derivatives exposure but rather
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 (17113)
finished this week about 44.6% above Fair Value (11829) while the S&P (1982)
closed 35.0% 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 stats
continued to disappoint this week. While
poor existing home sales and durable goods orders were partially offset by
promising new home sales, the balance of data continues to at least hint that
the economic global slowdown is starting to impact the US. Reinforcing that notion, the numbers out of
Japan and the EU this week remain subpar.
It is still too soon to alter our forecast, but clearly the more stats
we get pointing to a slowdown, the more probable it becomes.
Perhaps more
important than the data has been investor reaction to the data. Market sentiment changed noticeably after the
FOMC meeting. The pin action in stocks,
bonds, commodities and currencies became disjointed as each market appeared to
be discounting its own separate scenario.
And that only muddies the clarity on the future course of both the
economy and the Markets. I have no clue
what this all means but one thing I can say it is that when the outlook becomes
more uncertain, the directional momentum in prices diminishes.
The Russia/West
standoff raised its ugly head this week.
While Putin has pretty much what he wants in terms of territory, he
clearly is not going to lower his profile when challenged---as illustrated by
Russia’s move toward freezing foreign assets and threatening to shut off gas to
all of the EU. This keeps alive the
prospect of some geopolitical flare up as long as the West keeps pushing for
more sanctions. Investors’ reaction
Thursday to the most recent Russian countermoves is an indication of the magnitude
of the risk one of those geopolitical flare ups carry in investors’ minds.
The situation in
the Middle East can only be described as the greatest clusterfuck in the
history of US foreign affairs. Obama
seems to think that He can imagine some ideal outcome and then micromanage a
war to that end. Once again He
demonstrates His complete lack of understanding of history. I have no idea how this mess ends. My hope is that the players are too busy
killing each other to have the time to come after the US---the operative word
being ‘hope’.
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 increasingly at risk).
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.
On being wrong (medium and a must
read):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 9/30/14 11829 1468
Close this week 17113
1982
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
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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