The Closing Bell
10/18/14
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 Downtrend 15808-16881
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 Downtrend 1182-1943
Intermediate
Term Trading Range 1740-2019
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 mixed to the positive: positives---weekly mortgage
applications, September industrial production, the October Philly Fed
manufacturing index, September housing starts, initial October consumer
sentiment and weekly jobless claims; negatives---weekly purchase applications, September
retail sales, the October NY Fed manufacturing index, September building
permits, August business inventories and sales, September PPI; neutral---weekly
retail sales and the September NFIB small business optimism index.
September retail
sales (a negative), housing starts (a plus) and industrial production (a plus) were
the important numbers this week, giving us the first week in some time with a somewhat
positive bias---with two out of the three primary indicators to the upside. However, many of the stats were below
expectations and the disappointing building permits number diminishes the
strength of the housing starts plus. So
hold off opening the champagne. Further,
it is way too soon to know if this marks a turn in the dataflow or if the housing
starts and industrial production reports were simply outliers. However, it does for sure, at least, slow the
momentum for any change in our forecast.
In short, our
outlook remains the same, but the primary risk (the spillover of a global economic
slowdown) remains just so and, indeed, has increased a bit since our last
Closing Bell.
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.’
Update
on big four economic indicators (medium):
The pluses:
(1)
our improving energy picture. The US
The
negatives:
(1) a
vulnerable global banking system. The misdeeds continue:
UK banks pay
fines for selling complex derivative products to unsophisticated clients
(medium):
The impact of
one time charges on Bank of America’s earnings (medium):
Why Citi’s
Mexican subsidiary ‘mints money’ (medium):
Too big to fail
banks face $870 billion capital gap (medium):
Now that
investors are starting to question valuations, the question is what is going to
happen to the trillions of dollars of derivative and ‘carry trade’ positions now
held on bank balance sheets? I don’t
have the answer but as Mr. Buffett has suggested, if the tide goes out, we will
soon know who was swimming naked.
‘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.’
On the other
hand, our ruling class now has a couple of non-fiscal, non-regulatory issues
with which it must deal---Ukraine and the steady progress of ISIS in Syria/Iraq. Regrettably, our leaders have to date proven
as inept at handling these issues as they have tax, spending and regulatory
matters.
(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, I
have long maintained that central bank QEInfinity has had only a marginal
impact on their respective countries’ economies. Evidence of that is everywhere: (1) Europe is
sliding toward recession and Draghi admits that his ‘whatever is necessary’
measures have failed to deliver and will continue to do so in the absence of
fiscal reform, (2) a former director of the Bank of Japan opined that it was
time for the BOJ to taper---this in the face of terrible numbers and a failed
bond purchase program and (3) even if we assume that this week’s upbeat stats
are a sign that the US economy is not presently slipping into recession, there
still is no indication that the growth rate is picking up. And the unicorn and pixy dust comments of the
dream weavers aside, the US economy remains in danger of falling victim to the
malaise infecting Europe, Japan and, God forbid, perhaps China.
The damage done to the US
economy (medium):
The damage done
everywhere (medium and today’s must read):
Of course, far
be it from egghead academics populating the central banks to allow front page
substantiation of their colossal policy failure to sway them from their
appointed tasks. So our Fed is now
mewing about delaying the end of tapering, the ECB is proceeding with another
round of asset purchases after receiving memos from Germany, France and Italy that
they have no intent of pursuing Draghi’s fiscal recommendations and the
Japanese can’t get the latest easing moves properly executed because they have
fucked their markets up so badly.
In short, nothing
has changed at banking central. But then
nothing that the banksters have done has impacted the global economies.
The problem, of
course, is that the primary effect of QEInfinity has been on asset prices which
kept getting more and more overvalued. In
other words, while the US economy improved modestly, the EU economies stagnated
and the Japanese economy fell in the toilet, assets have been priced in
Nirvana.
Certainly, I
thought that this nonsense would have ended long ago and clearly I was wrong. But my hope remains that the Markets will
begin to ignore the central bankers and take matters into their own hands. If the latest Market ripple is a sign of that,
then please remember the obverse of my original contention---that unwinding
QEInfinity will have only a marginal impact on the economy.
(3)
rising oil prices [geopolitical risks]. Well, based strictly on the pricing aspect,
this is not only not a potential negative, it has become a positive. Clearly, diving oil prices are a boon to
consumers and any industries in which energy is a major component of its cost
structure. This frees up income for
spending on other goods or investments and that is a plus at a time of mounting
concerns about a slowing global economy.
There are a lot
of theories out there on what is driving prices down other than just the simple
supply/demand equation---which most certainly accounts for a part of momentum
to the downside. However, historically
Saudi Arabia, which has always served as the price control lever within OPEC,
ordinarily would be reducing production in the wake of a price decline. That is not occurring. The most reasonable explanation is that together
with the US [which is now the second largest oil producer in the world] they
are pushing prices down to punish Russia and Iran---both their enemies and both
having economies highly dependent on oil revenues.
I point this
out because this is basically economic warfare; and in any kind of warfare, one
must expect a response from the opposition.
I have no idea what that response might be. I am just saying that while lower oil prices
may be good news short term, there is a backend to this positive and it could
be quite negative.
Counterpoint:
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The dataflow from around the
world continues to point to slower growth.
On top of that [a] Draghi, by his own admission, has come to realize
that the ECB really can’t do ‘whatever is necessary’ and that fiscal reform is
a key element to economic improvement within; regrettably, based on comments and
actions from France and Italy, it appears that fiscal reform is nothing but a
wet dream, [b] similarly, Abe is starting to get some push back on his moronic
drive to print the country into prosperity.
This week, a former director of the BOJ basically stated ‘enough is
enough’, start tapering.
Must read piece
from David Stockman (medium):
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.
Bottom line: the US economy continues to progress though with
each passing week’s dataflow, that proposition is being increasingly called
into question. The economic news from Japan, China and Europe, three of our major
trading partners, keeps getting worse. And more important, there appears little
likelihood of the necessary fiscal reforms that would remove many of the
burdens to growth that these economies must bear. Nor is there any sign that suddenly QE is
working.
Geopolitically,
the world is a mess. The standoff in
Ukraine maybe on the back burner, but it is not over; and winter (i.e. the need
for gas) is rapidly approaching. The
ground action in Syria/Iraq is going against us. I don’t know for sure what impact a headline
reading ‘ISIS takes Baghdad’ would have.
My guess is ‘not good’.
Furthermore, if I am correct that the decline in oil prices at partially
represents a form of economic warfare, then I suspect that this is story that
doesn’t end well either.
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 applications were up but
purchase applications were down; September housing starts were up more than
expected but building permits were up less,
(2)
consumer: weekly
retail sales were mixed; September retail sales were disappointing; weekly
jobless claims were much lower than anticipated; the initial October consumer
sentiment index was better than estimates,
(3)
industry: September industrial production was much
stronger than forecast; the October NY Fed manufacturing index was well below
expectations while the Philly Fed index was up slightly; August business
inventories were up less than anticipated and sales were down; the September
NFIB small business optimism index was basically in line,
(4)
macroeconomic: September PPI was negative.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16380, S&P 1886) gave us another wild ride this week. The Dow closed within a short term downtrend
(15808-16881), an intermediate term trading range (15132-17158) and a long term
uptrend (5148-18484). It also ended
below its 200 day moving average.
The S&P
finished within a short term downtrend (1812-1943), an intermediate term
trading range (1740-2019), a long term uptrend (771-2020) and below its 200 day
moving average.
Volume rose slightly;
surprisingly, breadth was mixed. The VIX
fell 12%, ending within a short term uptrend.
It also closed back below the upper boundary of its intermediate term
downtrend, negating Thursday’s break. It
also finished above its 50 day moving average.
The long
Treasury sold off on Friday, closing below the lower boundary of its very short
term uptrend. If it stays there at the
close Monday, the trend will re-set to a trading range. It remained within a short term uptrend, an
intermediate term trading range and above its 50 day moving average.
GLD was also down
on Friday, ending below the lower boundary of its very short term uptrend. A finish there on Monday will confirm the
break and re-set the trend to a trading range.
It remained within short and intermediate term downtrends and below its
50 day moving average.
Bottom line: there
was a lot of technical damage done this week.
While Friday’s pin action provided some relief, there is little to
suggest that the downside momentum has been broken. Levels to watch next week will be the indices’
200 day moving averages as well as the lower boundaries of their former short
term trading ranges (support) which now have become resistance. If prices can break back above those levels,
then this round of lower prices could be over.
If not…………
One possible hint
as to future price action is the performance of the NASDAQ which had broken
both its short and intermediate term uptrends and in the subsequent rally was
unable to regain the lower boundary of either trend. Remember, (1) the small caps have led this
market down---and as of Friday, they are giving no sign of a lift and (2) the
violent bounces in down markets generally occur in the large caps---which is
what happened on Friday.
Our strategy remains to do nothing. I would use any rise in prices 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 (16380)
finished this week about 38.4% above Fair Value (11829) while the S&P (1886)
closed 28.4% 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
improved this week. Though as I often
point out, one week does not a trend make.
Nonetheless, it was better than a sharp stick in the eye and at least,
keeps alive the prospect that I won’t have to lower our growth forecast. That said, the numbers from our primary
trading partners remain dismal at best; and hence, provide no relief from the
major risk to our outlook---an economic slowdown in the rest of the world that washes
on to our shores.
More important,
the likelihood of major fiscal reform---which is the real solution to global anemia---declined
this week as the major powers within the EU all poo pooed Draghi’s call for
reform. And to put a cherry on top of
this turd sundae, the central banking community joined in a chorus of promise
to slow tapering (US), engage in another round of asset purchases (EU) and
pursue more asset purchases (Japan). All
somehow oblivious or completely unwilling to consider the prior failures of
QEInfinity---witness these amazing comments from Yellen on Friday.
Of course, given
Friday’s ebullient Market performance following the aforementioned chorus, it
is clear that the promise of more, cheaper money still has the requisite impact
on investors. As I have said too often,
it is in the mispricing of assets not the improvement in economic fundamentals where
the central banks have had their affect; and
despite my earlier thought that this might be coming to an end, it appears that
it is not to be. How long this continues
is anybody’s guess; but I believe that the longer it does, the more dire the
consequences.
Aside from
global economic malaise, the other potential sources of Market heartburn
managed to stay out of the headlines this week: the war in Iraq/Syria and
standoff in Ukraine. I don’t believe
that we have witnessed the final act in either of these tragedies; nor do I think
that the odds are high that they will end well.
But for the moment, investors seem content to ignore them.
Ebola has become
the new kid on the block as far as the ‘fear’ list goes. Despite the fact that I live in Dallas, I still
fail to see this as likely to have a lasting impact on the economy. Sure mistakes have been made, some
preventable but all clearly a function of hidebound bureaucracy. But Americans, even of the bureaucratic variety,
are still among the most resourceful and adaptive people in the world when need
be. And I think that will prove the case
here.
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.
The good news about declining markets
(medium):
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 10/31/14 11852 1472
Close this week 16380 1886
Over Valuation vs. 10/31 Close
5% overvalued 12444 1545
10%
overvalued 13037 1619
15%
overvalued 13629 1692
20%
overvalued 14222 1766
25%
overvalued 14815 1840
30%
overvalued 15407 1913
35%
overvalued 16000 1987
40%
overvalued 16592 2060
45%overvalued 17185 2134
Under Valuation vs. 10/31 Close
5%
undervalued 11259 1398
10%undervalued 10666
1324
15%undervalued 10074 1251
* 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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