The Closing Bell
11/22/14
I am taking Thanksgiving Week off.
Back on 12/1. I hope everyone has
a great Holiday.
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 16084-18830
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 1861-2215
Intermediate
Term Uptrend 1697-2413
Long Term Uptrend 783-2062
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
and purchase applications, October new home permits and existing home sales,
November homebuilders confidence, the NY, Kansas City and Philly Fed
manufacturing indices and the October leading economic indicators; negatives---October
housing starts, October industrial production, the November Markit PMI and
October PPI and CPI; neutral---weekly retail sales and weekly jobless claims.
Included in the
above are a number primary indicators which are pretty evenly balanced. On the plus side: housing permits, existing
home sales and leading economic indicators; on the negative: housing starts,
industrial production and the Markit PMI.
However, balanced is good news in our forecast. So the more numerous positive stats coupled
with an even split among the primary indicators fits well into our current outlook
and importantly, demonstrates that the US continues impervious to foreign economic
difficulties.
As you know,
global recession is the biggest risk in our outlook and we got no relief this
week on that front. The numbers were
awful---all of which I will cover below.
So 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. The banksters almost made it through a whole week
without any new revelations of misdeeds.
Unfortunately for them, the politicians have decided to take an interest
in bank malfeasance---the senate will begin hearing on commodity price rigging
by JP Morgan and Goldman Sachs. I doubt
anything will come of this other than grandstanding face time for the pols. However, it helps keep the crimes and
misdemeanors perpetrated on investors in public view and certainly won’t be a plus
for the big banks reputations.
Later it was
revealed that a NY Fed employee had shared confidential information with
Goldman Sachs about one of its clients.
It just goes on and on.
Problems in the
emerging market banking systems (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. The elections turned out as expected;
and Obama, true to form, ignored the results.
Three issues were front and center this week: (1) Obamacare. The supposed architect of Obamacare just can’t
keep his mouth shut as new videos keep appearing in which he disses the
American people and makes a mockery of our Socialist in Chief’s transparency, (2)
immigration. Obama changed US
immigration policy by executive order on Thursday. Given the ‘hot button’ nature of this issue,
this almost insures a rancorous next two years.
Great entertainment for the six o’clock news, and assuring gridlock,
which is fine for keeping spending under control, but worthless when it comes
to budget, tax and regulatory reform that this country needs to pull it out of
six years of subpar growth, (3) Keystone pipeline. The senate [Mary Landrieu] tried and failed
passage. Forget that it brings the US
even closer to energy independence, creates jobs and builds infrastructure [a favorite
Obama theme], consensus is that Obama will veto this measure once it passes a
new senate vote in January/February adding some heft to the high value
entertainment, gridlock, and lack of reform scenario.
(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 ended QE [though in the FOMC minutes released this week, it left the door
open ever so slightly that it may chicken out on raising rates]:
[a] Japan is
just getting started [though this week, Abe called a snap election to confirm approval
of this policy. What happens if he loses
that bet? Just asking.]
Japanese poll:
Thoughts on the Japanese economy (short):
[b] Draghi,
well let’s just say that while he is having a rough time getting consensus among
the central bankers on QE, he is having no problem jawboning it. Indeed, Friday he once again promised that
the ECB is ‘ready to expand’ its asset purchase program. While investors are getting jiggy with it, it
remains to be seen just how much he can do.
[c] on Friday,
the Chinese central bank cut its benchmark interest rates which really had the
stock guys tip toeing though the tulips
This all leaves
the financial markets with plenty of liquidity, keeping the hedge funds, carry
traders and yield chasers supplied with fuel to continue pumping up asset
prices.
Ignored, of
course, is the uncomfortable fact that QE hasn’t worked in the US [however,
dearly the Fed may cling to it], hasn’t worked in Japan [which is a complete
basket case; so much so that Abe has called for new elections to confirm
support for his version of QE], and it won’t work in Europe because it won’t
address Europe’s problems---too many bureaucrats, too much regulation, too much
sovereign debt and an overleverage banking system.
The danger, of
course, is that (1) the central bankers can’t wean themselves from QE, so
global liquidity continues to expand, (2) their respective sovereign
governments are unwilling to provide the real solutions to that which is
inhibiting economic growth and (3) at some point an exogenous event occurs
which stops the music.
Of course,
since all that liquidity has done nothing to spur economic growth, its absence will
likely do nothing to inhibit it. On the
other hand, asset prices have done a moon shot on the back of QE; so I am
assuming that a decline in liquidity will have some counterproductive impact on
those prices.
(3)
geopolitical risks. Ukraine/Russia stayed out of the headlines
this week though Putin continues saber rattling [he said that he won’t allow
the defeat of Ukrainian rebels] and moving forward with attempts to ameliorate
sanctions. The Middle East was also comparatively quiet, save
for the ongoing low level violence---which is of little consolation to those who
died. Despite this relative calm, this
is the source of a potential exogenous factor that could produce the loudest
bang.
(4)
economic difficulties,
overly indebted sovereigns and overleveraged banks in Europe and around the
globe. The debacle continues this week as
PMI’s around the world [including Germany and China] were reported to have
declined. But perhaps the biggest
headline was that Abe formally announced a delay in the second tax cut [good news
both economically and politically], called for new elections in December in the
search [hope?] for a mandate/approval of his policies and to hedge his bets, he
threw some new spending proposals to try to buy at least a few votes. If he wins, the Japanese citizenry loses
because nothing [i.e. recession] will change.
If he loses, the question is what policy changes are going to take place
and how will they impact global markets?
Talk about a potential exogenous event.
Bottom line: the US economy continues to struggle along
and, at least for the moment, appears strong enough to withstand any negative
fallout from a slowing world economy. The
rest of the globe once again produced economic results that pointed to
recession, leaving that as number one on our risk hit parade.
Abe is putting
his economic policies on trial. The bad
news is that whether he wins or loses, the outcome is likely to be negative
long term. The good news is if he wins
Japanese QEInfinity marches on in the short run and with it the asset price
chasing of hedge funds, carry traders, yield chasers and prop trading desks.
China moved to
ease monetary policy and Draghi is once again promising QE, though I think that
this is just more of his ‘whatever necessary’ rhetoric which to date has never
been backed up by action. So for the
time being, financial markets are awash with cheap, easy money.
On the geopolitical
front, there was little news this week.
While the odds of a disastrous exogenous event occurring may be small,
the magnitude of the consequences of such an event are enormous.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up; October housing starts fell but permits were up; October existing home
sales were better than anticipated; November homebuilder confidence was up,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims were down less than consensus,
(3)
industry: October industrial production and capacity utilization
fell; the November Markit PMI was disappointing; the November NY and Kansas
City Feds’ manufacturing indices were slightly better than expectations, while
the Philly Fed index blew that doors off estimates [however, as I noted Friday,
it seems likely to me that this number will be revised],
(4)
macroeconomic: the October leading economic indicators
rose more than anticipated; PPI for final demand rose much more than consensus;
the headline and ex food and energy CPI came in slightly hotter than expected.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17810, S&P 2063) continued their sideways consolidation early
in the week, then spiked on Friday after QE good news from China and Draghi. The Dow closed in uptrends across all timeframes:
short term (16084-18830, intermediate term (16053-21083) and long term
(5159-18512).
The S&P
finished one point above the upper boundary of its long term uptrend
(983-2062). That starts our time and
distance discipline. If the S&P
remains above that upper boundary though the close next Friday, the break will
be confirmed. Of course, the question
becomes, then what? How do you measure
how far up is, when the S&P is already over its upper boundary? My initial thought is that if it exceeds the
upper boundary by the same magnitude that it did at the 2007 high, the
potential upside target could be around 2450.
Of course, a lot
has to happen technically before we get serious about that kind of upside, i.e.
the break has be confirmed plus the Dow has to confirm its own break and it’s
still 700 points away from that. Furthermore, I think it important to note that
the S&P intraday traded well above 2062 on Friday but couldn’t hold that
magnitude of an advance. To fall back
and finish so near 2062 suggests to me that the quality of this break is not
that great. Nonetheless, the S&P has
challenged its upper boundary and I am just quantifying what the potential
upside if a break is confirmed.
Volume rose on
Friday but much of it was due to options expiration; breadth was strong. The
VIX fell, ending right on the lower boundary of its short term uptrend, closely
reflecting (inversely) the action in the S&P. It continued within its intermediate term
downtrend and below its 50 day moving average.
The long
Treasury was up and is close to breaking out of its very short term trading
range. It remained within its short term
uptrend, its intermediate term trading range and above its 50 day moving
average.
GLD had another
strong day on Friday, ending (1) above the lower boundary of its former long
term trading range for the second day, leaving open the question as to whether this
boundary will prove to be effective resistance or mark the bottom in price for
GLD? and (2) very close to its 50 day moving average. Nonetheless, it continues to trade within
short, intermediate and long term downtrends.
Bottom line: the
markets are again in a period where numerous boundaries are either being or are
very close to being challenged. While a
break to the upside in the S&P and a break down in the VIX would be
consistent, a rally in the long Treasury and a bottom in GLD are not. Nor are they necessarily consistent with a
strong stock market. The point here is
that there is a lot cross currents in multiple markets and not all the
potential outcomes are positive. I await
some clarity.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17810)
finished this week about 49.9% above Fair Value (11876) while the S&P (2063)
closed 39.7% 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.
US economic
progress appears to be back on track. On
the other hand, the global economy seems to be going from bad to worse. Japan is in recession and the latest PMI numbers
from around the world did not make great reading.
QE got a boost
this week from an interest rate cut by China and more ‘whatever necessary’
rhetoric from Draghi. So QEInfinity is
alive and well and investors are loving it.
Politically, the
conditions have deteriorated. Aside from
a more belligerent Putin, violence in the Middle East, the prospect of a
nuclear Iran, (1) in the US, Obama has started a fight in which gridlock may be
the good news outcome, (2) the EC is thumping France on the wrist over its 2015
budget---not a good sign for concerted policy action to avoid a recession and (3)
Abe has called for elections to validate his economic policies. Given their disastrous results, I can’t
imagine that the electorate would give him a thumbs up. But he is the politician, so he seems to
think that he will win. If he is right, I
am going to stop feeling sorry for the Japanese electorate. On the other hand, if he loses [which
incidentally, no one is talking about], there is the potential for the Mother
of All Policy Reversals.
Yet all of the
above remain only potential risks; and in the meantime, in addition to better US
economic numbers and an enhanced QE, corporate profits are still rising, the
dollar is strong, Japan is pumping out liquidity at a historically
unprecedented rate and Santa Claus in coming to town.
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 17810
2063
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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