The Closing Bell
1/10/15
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 16372-19142
Intermediate Term Uptrend 16372-21542
Long Term Uptrend 5369-18960
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short Term Uptrend 1889-2281
Intermediate
Term Uptrend 1729-2443
Long Term Uptrend 783-2083
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 47%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 49%
Economics/Politics
The
economy is a modest positive for Your Money. The US
economic data this week was mixed: positives---the December ADP private payroll
report, weekly jobless claims, December nonfarm payrolls, December retail chain
store sales, the November US trade deficit; negatives---weekly mortgage and
purchase applications, the December Markit services index, November factory
orders, the December ISM nonmanufacturing index; neutral---weekly retail sales,
November light vehicle sales, December consumer credit.
As you can see,
these stats are pretty well balanced not only by volume but also among the
primary indicators. Hence, they fit our
forecast perfectly. But as important,
there continues to be no sign of a spillover of global economic weakness into
the US.
Also deserving
of comment was the limp wristed language in the latest FOMC minutes. That is, it was another confused narrative,
full of the usual ‘on the one hand/on the other hand’ noncommittal disclosure
that conveyed the lack of conviction to do anything that would upset the
Markets. Humbug. That was followed by a speech from a member
of the FOMC that included a statement that a rise in interest rates would be
catastrophic. Score two for the
QEInfinity crowd. My bottom line on this
factor hasn’t changed---QE does little for the economy but does help make the
speculators, hedge funds and carry traders richer.
The numbers from
overseas showed no sign of improvement---not good. Plus we now have some new wrinkles in this
otherwise dismal picture: the net effect of declining oil prices on the global
economy as well as the potential fallout from the upcoming Greek elections
(which is to say, a Greek default). However,
we have seen no economic signs of either, save the direct impact of lower oil
prices on those countries in which oil production is a major component of GDP.
Hence, 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
The pundits
keep telling us that cheaper oil is a significant plus for the economy; but
stocks keep cratering as oil prices decline.
Curiously, to date, nothing has showed up in the macro numbers that
would support either case for the energy consuming countries; effects are being
felt in the economies of energy producing countries
Until we get
more substantive evidence on the impact of lower prices for the US, I am
leaving this factor as a positive.
However, I am not going to stop worrying about the negative case, in
particular, the extent of bank lending to the subprime sector of the oil
industry.
The
negatives:
(1) a
vulnerable global banking system. The gem of the week was Citicorp upping its
exposure to the derivative trading/market.
This at a time that most other banks are lowering their activity. I am assuming that this is somehow related to
the recent [GOP sponsored] amendment of Dodd Frank that rolled back a provision
forcing banks to divest a segment of their derivative trading operations. Whatever the reason, it will almost surely
keep your and my prospective liability from the gross mismanagement of the
banking system higher than any of us want.
Here’s another
gem from the grand old party (medium):
The Alice in
Wonderland math of the banks’ derivative trading (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. Congress managed to do something constructive this week: it tasked the
congressional budget office to dynamically score all future forecasts [meaning
taking indirect as well as direct consequences of legislation/regulation into
account; for instance, a tax cut may lower government revenue by the difference
in the two rates; but it will also spur economic activity that will increase
profits and hence tax revenues]. Score
one for the good guys.
On the other
hand, in Obama’s drive for a new spirit of cooperation, He announced that He
would veto the current Keystone Pipeline bill.
No invitations to congressional leaders to meet with Him and try to
hammer out a compromise. No specifics on
why He would veto it. Just ‘if you pass
it, I will veto it’.
As you know, I
have long maintained that Obama was an ideologue and incapable of
compromise---the importance here being that if I am correct, we are looking at
two more years of gridlock. Of course,
there are worse things than gridlock; so my comment shouldn’t be construed as a
total negative. On the other hand, it
appears that tax and regulatory reform are more than two years away at a
minimum.
But there is
still plenty of time for Obama to give more of Your Money away (medium):
(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.
The QE juices
got pumped up this week by:
[a] the tone of
the latest FOMC minutes---they being read as implying easy money {low rates}
longer than many had thought. Bolstering
this interpretation were comments from a Board member the same day
characterizing a rise in interest rates as potentially ‘catastrophic’. The combination got the QE crowd really
jacked up. But in the end, it is the same old shit: QE does nothing for the
economy but the failure of the Fed to tighten in a timely manner is just
another in a whole history of botched policy fiascos.
Stephen Roach
on Fed policy (3 minute video and a must watch):
[b] the economic
data out of Europe continue to be dismal, supporting Draghi’s case for an ECB
QE. From the analysis that I have seen,
I don’t think that the ECB has the ability to do much; certainly nothing to
compare with the Japanese or US QE. But
then it has done virtually nothing to date except gab and investor have still
gotten tingly all over whenever Draghi gives his ‘whatever is necessary’
bullshit line.
(3)
geopolitical risks. Except for the Paris massacre, the world was
relatively quiet this week. Despite this 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 economic data from the
rest of the world showed little improvement this week. Most of it came out of Europe and included
only one upbeat stat---German unemployment.
That keeps fears of increasing deflationary pressures alive and
well.
In addition, as
oil prices fall, their impact on the economies of the oil producing nations should
also act as a governor on global growth---but we have seen no evidence of that
to date.
And then
there is the potential Greek exit from the Eurozone and the problems attendant
to it, specifically a default on its sovereign debt and the impact that would
have on the EU banking system. German
officials have been clear that they are ready for such an action and that the
EU economy can handle it just fine. That
likely contains a healthy dose of propaganda; but we are not going to know for
sure unless it really happens.
I have
suggested, absent any improvement in worldwide economic growth that sooner or
later the US is bound to be infected. Perhaps
even a larger worry is that while sovereign economies have been treading water
or even declining, their debts both sovereign and corporate have been
growing. I don’t need to tell you that is
a toxic combination that unless reversed will [a] impair the issuers ability to
service that debt thereby increasing the risk of a sovereign default {see
Greece} and/or [b] lead to bankruptcies within a global financial system that
is not only overleveraged but holds excessive amounts of highly speculative,
low quality assets.
Europe’s
largest bank needs capital (medium):
China is also
facing some tough economic decisions (medium):
This is far too
complicated a situation for me to assume that I can predict the point at which
the US economy starts suffering from this global malaise or sovereigns and
banks run out of cash flow to service their debts; but I do know that there is a clear risk of it happening; so this
remains the biggest risk to our forecast.’
Bottom line: the US economic news was mixed this week but
there was nothing to suggest that our forecast is at risk or that any negative fallout
from a slowing world economy is at our door.
The QE advocates
received a much welcome spike to the punch bowl as the Fed uselessly
equivocates over raising interest rates and central banks everywhere promise
more monetary ease with each release of even more disappointing economic indicators.
Not that that has been shown to be a recipe for improving growth; but who needs
that fact when stocks prices are roaring.
Falling oil
prices, a strong dollar and the potential Greek exit from the EU were the
principal headlines this week. All hold
the potential for disruptive consequences.
This week’s
data:
(1)
housing: weekly mortgage applications and purchase
applications were terrible,
(2)
consumer: weekly
retail sales were mixed; December retail chain store sales rose; December light
vehicle sales were in line; the ADP private payrolls report was better than
forecast while weekly jobless claims fell less than consensus; December nonfarm
payrolls were better than anticipated; December consumer credit rose but credit
card debt declined,
(3)
industry: the December Markit service index was slightly
below estimates; November factory orders were down; the December ISM
nonmanufacturing index was less than expected,
(4)
macroeconomic: the November US trade deficit was lower than
forecast; the minutes from the last Fed meeting was more pabulum for the
speculators, hedge funds and carry trade crowd.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17737, S&P 2044) had a roller coaster week (down, up, down) but
still closed within uptrends across all timeframes: short term (16372-19142, 1889-2281),
intermediate term (16372-21541, 1729-2443) and long term (5369-18860, 783-2083).
Both of the
Averages closed right on their 50 day moving averages, having traded below that
boundary, then back above it. In addition,
both are developing pennant patterns (higher lows and lower highs) which, in
technical terms, ultimately get resolved by large directional moves. Further, they are now within a narrowing
spread between the lower boundaries of their short term uptrends and the upper
boundaries of their long term uptrends---with the S&P in an especially tight
range. The only resolution to this is
that one of the trends is successfully challenged. And last but not least, the seasonal patterns
are about as confusing as could be: the Santa Claus rally didn’t happen
(negative), the trading in the first two days of January was down (negative)
and a virtually assured negative first five trading days of January was
thwarted by a fifth day moon shot to barely score a plus for this indicator
which was then followed by a dive in prices.
Coupled with the dramatic volatility, this pin action suggests investor
uncertainty/schizophrenia and leaves me directionally clueless.
The levels to
watch are (1) on the upside, the former (unsuccessfully challenged) highs
(17998, 2080), the upper boundaries of the developing pennant formations and
those existing long term uptrend upper boundaries and (2) on the downside, the
last higher low, the lower boundaries of the developing pennant formations and
the lower boundaries of their short term uptrends.
Volume fell on
Friday; breadth deteriorated. The VIX jumped, closing within a two and a half
year short term trading range, an intermediate term downtrend and above its 50
day moving average. The VIX is also
experiencing a narrowing gap between two boundaries, in this case the upper
boundary of its short term trading range and the upper boundary of its
intermediate term downtrend. In fact,
they are a short hair away from crossing.
Once that happens, then any move to the upside would violate one or both
of these boundaries.
The long
Treasury moved up strongly again. To
illustrate the strength of the current move, it finished above the upper
boundary of its intermediate term uptrend, right on the upper boundary of its
short term uptrend and well over its 50 day moving average.
Thoughts on the
long term outlook for bonds (medium):
GLD was also up on
Friday, closing within a very short term uptrend, a short term trading range,
an intermediate term downtrend, a long term trading range and above its 50 day
moving average. It is fighting to make a
bottom.
Bottom line: the
Averages were all over the map this week.
While the uptrends across all timeframes remain solidly intact, there
was a touch of schizophrenia in trading.
Not so much to be technically alarmed, but enough to notice, especially
with bonds soaring and GLD attempting to score a turnaround.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17737)
finished this week about 48.6% above Fair Value (11933) while the S&P (2044)
closed 37.8% overvalued (1483). 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.
As a result of
this week’s data/events, the overall investment picture remains basically the
same: the US economy sluggishly improving (but we know that the US has been slowly
growing); the rest of the world’s major economies either in a recession or
struggling to stay out of one (but we know that and they have yet to impact the
US); the largest central banks doubling down on QE (but we know that and that
they have little to show for it); to which have been added a couple of wild
cards: collapsing oil prices (which has yet to influence the US economy or those
of the other major oil consuming nations) and the potential exit of Greece from
the EU (which hasn’t happened yet).
In sum, that
leaves our forecast in tact with a global slowdown, irresponsible monetary
policy, higher oil prices and a Greek exit simply risks to that outlook. Not that any or all of them won’t
happen. But even if they do, I have
already factored several of them into our economic forecast and Valuation Model;
and the spread between our Valuations and current prices is so large, making it
larger would have little meaning.
In fact, in our
calculations, to get prices where they are now, none of the aforementioned
risks can materialize, indeed nothing negative can occur and US economic growth
is the next five years has to match the strongest real growth rate in our
modern history.
So I remain in
the unusual position of expecting a positive economic scenario but a lousy
market. What ties those two contrary
notions together is monetary policy or to be more specific, QE. The past six years have witnessed an
unprecedented monetary explosion not just here but in many of the major central
banks. While doing little for their
respective economies, QE has fed into the coffers of the big banks and other
high powered institutional traders allowing them to borrow very cheaply and, in
pursuit of a positive yield spread, use those funds to chase asset prices into
their current nosebleed territory. Hence
a scenario the leaves the US economy slowly growing but witnesses a vicious
mean reversion in securities prices seems a reasonable expectation.
I don’t know
what is going to reverse this madness and I don’t know when it will
happen. But I do know that that
valuations are stretched to such extremes that when it does happen, I am
probably not smart enough or quick enough to be the first guy out the door. And there is likely only going to be
one. Hence, I would rather forego any
profit earned in an environment of excessively high valuations in order to
avoid what will likely be far greater losses when this fairy tale comes to an
end.
Bottom line: the
assumptions in our Economic Model haven’t changed though our global ‘muddle
through’ scenario is at risk with lower oil prices and economic disruptions
from a potential Greek exit from the EU suddenly developing into a potentially dark
underside. 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 2015 Year End Fair Value*
12300 1525
Fair Value as of 1/31/15 11933 1483
Close this week 17737
2044
Over Valuation vs. 1/31 Close
5% overvalued 12529 1557
10%
overvalued 13126 1631
15%
overvalued 13722 1705
20%
overvalued 14319 1779
25%
overvalued 14916 1853
30%
overvalued 15512 1927
35%
overvalued 16109 2002
40%
overvalued 16706 2076
45%overvalued 17302 2150
50%overvalued 17899 2224
Under Valuation vs. 1/31 Close
5%
undervalued 11336 1408
10%undervalued 10739
1334
15%undervalued 10143 1260
* 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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