The Closing Bell
11/15/14
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 Uptrend 16053-18819
Intermediate Term Uptrend 16053-21053
Long Term Uptrend 5159-18521
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1841-2207
Intermediate
Term Uptrend 1692-2408
Long Term Uptrend 783-2056
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 weighed to the plus side: positives---weekly mortgage purchase
applications, October retail sales, September small business optimism, November
preliminary consumer sentiment, and the October budget deficit; negatives---weekly
mortgage applications, weekly jobless claims and the September combos of
wholesale inventories and sales as well as business inventories and sales; neutral---weekly
retail sales.
The most important
stat this week was the October retail sales number reinforced by consumer sentiment,
indicating that the largest segment of the economy (the consumer) remains
upbeat in both attitude and action. In
addition, the generally positive dataflow itself was important in that it emphasizes
that what at first appeared to be a negative trend in data is in truth just
another period of erratic stats---a pattern that has occurred repeatedly
throughout this entire recovery. How
many times in the past five years have we seen a month or two of either negative
or inconsistent overall stats, worried that it might indicate a rollover in the
economy only to be followed by the resumption of economic improvement---slow,
below average, but improvement nonetheless?
To be sure, this uneven trend doesn’t necessarily have to be followed a
more steady advance. But for the moment,
my assumption is that it will. The point
here being that, at least for now, the US economy appears to be warding off the
negative impact of a slowing global economy.
That said, the
slowing global economy just keeps slowing. Numbers out of Europe and China this
week indicate little improvement.
Granted France and Germany managed to turn in positive GDP growth for
the third quarter, but the rest of Europe was not so lucky and Germany scored a
plus figure (+0.1%) by a hair on its chinny, chin, chin. So while the US is holding in there, a
slowdown in the global economy still remains the number one threat to our
forecast.
In short, our
outlook remains the same, and the primary risk (the spillover of a global
economic slowdown) remains just so.
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
Unfortunately,
this positive in our outlook may be getting to be ‘too much of a good thing’. Whether because of new abundant supplies or
falling demand, the price of oil has been getting hammered of late; and sooner
or later this plus could become a minus.
‘I have no idea where the crossover point
is, but there is one in which the positive created by lower prices to consumer
and industry is offset by losses in employment and weakening corporate
financial structures resulting from decreased drilling activity (remember the
energy industry has been a major contributor to job growth and cap ex
spending).’
The
negatives:
(1) a
vulnerable global banking system. This week, global regulators fined five banks
$3.4 billion for price fixing in the foreign exchange markets. In a related action, the Bank of England
fired an employee for ‘serious misconduct’.
This is an
interesting and insightful article on the FX market and serves somewhat as a
counterpoint to the above (medium and a must read):
‘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. The elections turned out as expected;
and Obama, true to form, ignored the results.
Two issues appear likely to set the near term political agenda in DC:
(1) Obamacare. This week we all witnessed
several videos of the architect of Obamacare smugly discussing the lack of
transparency of the act which was intended to fool ‘stupid Americans’. Committee hearings to follow. (2) rumors are that Obama will change the US
immigration policy by executive order as early as this coming week, confirming
that He remains an ideologue and has no intention of working with Congress for
the remainder of His term. If it indeed
occurs, it is likely to ignite a shit storm that will keep us all entertained
for weeks. Meanwhile, where is budget
and tax reform?
More
revelations on Obamacare (medium):
And (short):
(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.
While the Fed
has ostensively ended QE, Japan is just getting started and Draghi is
threatening his own version, soon to be announced. That leaves the globe awash in liquidity and
provides the hedge funds and carry traders plenty of fuel to continue pumping
up asset prices. Ignored, of course, is
the uncomfortable fact that QE hasn’t [except for QEI], isn’t and likely won’t
do anything for economic growth.
True the US
economy continues to improve; but it has been and remains tough going. The underlying theory [easy money and higher
asset prices will drive spending and investment] for this disastrous experiment
[QE] has clearly not worked. One can
only assume that the US economy is where it is in spite of QE and more likely
the result of the ingenuity and hard work of industry and labor.
That leaves us
with the question, when all this money creation is over, will the global
economy be negatively impacted? You know
my opinion---no. Indeed, there is an argument
that its termination would be a positive.
On the other
hand, we know that all the QE’s have had a significant effect on asset
prices. One need look no further than
investor reaction each and every time some iteration of QE was announced or
confirmed. Whether an end to QE, when,
as and if it ever happens, will adversely impact asset prices remains to be
seen. As you know, I believe that it
will.
(3)
geopolitical risks. The main item this week is renewed hostilities
in Ukraine---this less than two weeks after Ukraine made its first payment to
Russia in accordance with an agreement on winter gas prices. It would seem Putin believes that he has
carte blanche to do whatever he pleases, whenever he pleases irrespective of
prior agreements. That doesn’t appear likely
to change given the weak response to date from NATO/US to his maneuvers in
Ukraine. Emphasizing his lack of concern
with NATO/US are increasingly aggressive bomber flights skirting NATO
airspace. Any bets on whether there is
more to come?
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The news out of the rest of
the world continued negative this week with UK and ECB lowering estimates of EU
growth; and most of Europe, except France and Germany, reporting poor GDP
numbers [and as noted above Germany’s report was hardly promising]. In addition, China reported downside misses
in fixed asset investment, retail sales and industrial production. In short, save for a brief respite a couple
of weeks ago, the economies of a majority of our most important trading
partners continue to deteriorate.
There was one
positive development, the Japanese are considering delaying the second retail
sales tax increase---perhaps a sign that the ruling class is starting to wake
up to the disaster they have created. The problem is that it maybe too little
too late. Time will tell.
A global
slowdown/recession remains the number one risk to our forecast.
Bottom line: the US economy showed signs of improvement
this week. On the other hand, economic
news from our major trading partners continues to deteriorate. The good news is that the US economy appears strong
enough at present to withstand such widespread global weakness. The bad news is that the operative words are ‘at
present’ and that keeps this factor as number one on our risk hit parade.
Global
QEInfinity marches on even without our Fed.
Japan has tripled down on its version while Draghi continues to insist
that he will let go with his own. That
leaves the hedge funds, carry traders, yield chasers and prop trading desks free
to push asset prices higher while the citizenry of Japan and Europe suffer the
effects of economic stagnation and those countries’ problems (too much debt and
overleveraged banks) remain unaddressed.
On the geopolitical
front, Russia continues to assert itself.
It is not out of the question that it will use its gas this winter to
achieve further gains at the expense of NATO/US. The Middle East remains a quagmire---ISIS, a
potentially nuclear Iran, an increasingly isolated Israel. If the US can escape this mess with some semblance
of honor, it will be a miracle.
This week’s
data:
(1)
housing: weekly mortgage applications were down but purchase
applications were up,
(2)
consumer: weekly
retail sales were mixed while October retail sales were stronger than
anticipated; weekly jobless claims were up and above forecasts; preliminary
November consumer sentiment was better than estimates,
(3)
industry: September wholesale inventories were above expectations
but sales rose less; September business inventories increased in line, but
sales were flat; the NFIB small business optimism index came in slight ahead of
anticipated results,
(4)
macroeconomic: the October federal deficit was less
than forecast.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17654, S&P 2039) spent the bulk of the week consolidating
from an extremely overbought condition.
The good news is that the pin action was basically sideways---the
optimal way of working off an overbought state.
The bad news was some deterioration in markers of internal
strength. As I noted in Friday’s Morning
Call, that doesn’t necessarily have to be negative, since it is reasonable for
that kind of action to occur in a period of consolidation. On the other hand, the S&P finished near
the upper boundary of its long term uptrend which typically represents a tough
barrier to cross. So the consolidation/weaker
breadth measures could either be with us for a while as stocks continue to
build strength for an assault on S&P 2056 or this action is a preamble to a
roll over.
All that said, both
of the Averages closed within uptrends across all timeframes: short term
(16053-18810, 1841-2207), intermediate term (16053-20153, 1692-2408) and long
term (5159-18521, 783-2056). They are
also finished above their 50 day moving averages.
Volume fell on
Friday; breadth was mixed. The VIX also declined, ending within a short term
uptrend (but back near the lower boundary), an intermediate term downtrend and below
its 50 day moving average.
The long
Treasury rose on Friday, closing within a very short term trading range, a
short term uptrend, an intermediate term trading range and above its 50 day
moving average.
GLD had another
strong rebound on Friday. While it ended
within short, intermediate and long term downtrends, it closed near the lower boundary
of its former long term trading range.
The question is, will that level act as resistance or was the recent
break of the long term trading range a false flag and a recovery above it mark
a bottom in GLD? Too soon to know and
way too soon to bet any money on it.
http://www.etf.com/sections/index-investor-corner/23821-swedroe-gold-is-a-hedgeif-you-have-time.html
And:
Bottom line: the
sideways consolidation of last week is a very bullish indication of more upside
to come; plus seasonal factors are a major plus. On the other hand, the S&P is near a
historically formidable barrier and some internal indicators could be signaling
a breakdown in long term momentum. We
are not going to know which for a while.
So patience.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17654)
finished this week about 48.6% above Fair Value (11876) while the S&P (2039)
closed 38.1% overvalued (1476). 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.
Stumbling economic
progress in the US, disappointments from all our trading partners, an Ideologue
in Chief unwilling to compromise, the rise of a new more aggressive version of the
Russian bear, chaos in the Middle East and historical valuation measures seem
to have no effect on investors as long as some central bank is willing to carry
the QE torch.
To be sure, corporate
per share earnings, which most certainly have an impact on equity valuations,
continue to hit new highs. But based
either current or forward earnings, valuations are still high. In addition a big part of the increase in earnings
per share is a function of (1) layoffs which is ultimately not good for the
economy and (2) easy money/low interest rates which allow companies to borrow
cheaply and buy back their own stock. In
other words, aggregate profits are not progressing nearly as much as per share profits;
and as soon as QE ends, the easy money source of this financial manipulation of
earnings per share will also end. That
said, I have no doubt that asset prices, whether driven higher by direct
purchases of carry traders and yield chasers (easy money) or by financially
constructed higher profits per share (easy money) or both, will likely continue
to levitate as long as QE goes on.
With valuations (which
I have thoroughly reviewed in the last two weeks) so out of whack, it makes no
sense for a fundamental long term investor like me to do anything other than
follow our established investment strategy---frustrating as it might be in the
short term.
Given the
current momentum and the very positive seasonal bias for stocks, if I had any skill
as a trader, I might try to ride this uptrend using very tight stops. My choice of instruments would be an ETF (VYM---low
risk; IWN—higher risk) so that I only had to worry about a single position from
which to escape.
However, my inclination
is more towards setting myself up for the downturn whenever it might
come---since that fits with my fundamental opinion of the Market. As I noted earlier in the week, I am watching
VXX (volatility), SH (the short of the S&P index) and GNT (a gold and
income [current yield is about 12%] trust).
In addition, I am tightening the quality criteria for inclusion in our
Universe with the thought of eliminating holdings that are on the cusp of qualification.
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 is 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.
DJIA S&P
Current 2014 Year End Fair Value*
11900 1480
Fair Value as of 11/30/14 11876 1476
Close this week 17654
2039
Over Valuation vs. 11/30 Close
5% overvalued 12469 1549
10%
overvalued 13063 1623
15%
overvalued 13657 1697
20%
overvalued 14251 1771
25%
overvalued 14845 1845
30%
overvalued 15438 1918
35%
overvalued 16032 1992
40%
overvalued 16626 2066
45%overvalued 17220 2140
50%overvalued 17814 2217
Under Valuation vs. 11/30 Close
5%
undervalued 11282 1402
10%undervalued 10688
1328
15%undervalued 10094 1254
* 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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