The Closing Bell
1/24/15
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 16450-19222
Intermediate Term Uptrend 16479-21634
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 1909-2290
Intermediate
Term Uptrend 1734-2448
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 49%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 51%
Economics/Politics
The
economy is a modest positive for Your Money. The US
economic data this week was sparse but weighed to the plus side: positives---weekly
mortgage applications, December housing starts and existing home sales, December
leading economic indicators, weekly retail sales and weekly jobless claims;
negatives---weekly (home) purchase applications, December building permits and
the January flash manufacturing PMI; neutral---none.
The overall
volume of positive indicators supports our forecast; although I don’t see
anything earthshaking in these numbers. To
be sure, the housing data is significant but, in total, it contained both good
and bad news. The only standout stat was the leading economic indicators which
is a big plus. On the other hand, the disappointing
earnings or guidance announcements continued though they did moderate a
tad. Of course, it is early in the
earnings season, so this trend could be easily reversed. But it is still a
phenomena that hasn’t occurred in seven years.
Could it be a microeconomic precursor to negative macroeconomic
data? It could but, as I said, it is too
early to know. Nonetheless, it is enough
to keep the flashing yellow light going after last week’s discouraging retail
sales and industrial production numbers.
The other big
news came from overseas, to wit, Draghi finally delivering on the promise of an
EU QE. He was joined in his QE quest by
the central banks of Canada, Denmark, Turkey and China. Not that these efforts will accomplish any
more, economically speaking, than the US or Japanese versions. Regrettably, now
that QE is all encompassing, it may set up a mad dash of competitive devaluations,
which is not likely to end well.
Nevertheless, the hope (which always springs eternal) among investors is
that it will keep asset bubble party going.
While there was
other discouraging developments oversea (see below), nothing has yet impacted
US macroeconomic data. Hence for the moment, our outlook remains the
same but with a bit less conviction (flashing yellow light) 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. To date, there is no solid evidence about
whether lower oil prices are good or bad for the overall economy. All we really have is the narrative from both
sides of the argument. True, some
microeconomic problems are quite visible---declining revenues, lower
employment, declining capex---within the oil and oil service industries. But there is nothing indicating an impact
that will alter the direction or growth rate of the economy.
As you know, my
concern is the magnitude of subprime debt from the oil industry on bank balance
sheets and the likelihood of a default.
Here too there is nothing substantial; just speculation about the
potential danger.
Speaking of
which, this from Goldman (medium):
So until we can
definitely say that lower oil prices are bad for the economy overall, 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
only potentially negative occurrence this week was the default of a major
Chinese real estate developer. There is
no direct evidence that this could be disruptive to the Chinese banking system;
although, the Bank of China did make a large infusion into the financial system
on Wednesday.
Another conceivable
headache could be awaiting us as the Greek elections take place tomorrow. The party currently leading in the polls has
made a whole host of unsettling campaign promises not the least of which is to
withdraw from the EU and refuse to honor Greek debts. Of course, the operative words are ‘campaign
promises’; and we know that there is an enormous gap between what politicians
promise and what they do. Nonetheless, if the new group plays hardball, it
could have a troublesome effect on those entities holding Greek
debt/liabilities [like the banks].
‘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 big [?] news here was
Obama’s state of the union address and all the new policy initiatives that He
announced. Of course, the whole thing
was DOA and hence lacks any significance except that it once again shows Obama
as an ideologue and not a politician willing to compromise.
(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.
Well, we got a
snoot full of QE this week, as the ECB along with Denmark, Turkey and Canada
joined the stampede to easier money and China injected funds into its banking
system.
On the surface,
my eight year old grandson knows that QE has done nothing to stimulate either
inflation or growth in any country that has tried it. However, the theory is, at least for the
growth part, that more money will stimulate increased bank lending and depreciate
[more supply = lower prices] of the country’s currency making its products
cheaper versus the competition. The
problem, of course, is that when everyone does it, it doesn’t work. And right now it appears that everybody’s
doin’ it, doin’ it, doin’ it.
But back to the
ECB QE for the moment, I am on record that Draghi really couldn’t match the size
of US or Japanese efforts [though the results, i.e. nothing, were a given]. Clearly, he is trying or, at least, says that
he is trying to equal their programs; although we are still a little short of
details. Nonetheless, we should know
more in the coming days; and if Draghi is not fading us and Germany goes along,
then I am going to be wrong on this call.
I will, however, stand by my statement that it is likely to be no more
effective than the US or Japanese versions.
David Stockman on ECB QE (medium):
(3)
geopolitical risks. Violence in Ukraine erupted again this week
with all parties pointing fingers while the shooting continued. In addition, ISIS rebels have overthrown the
government of Yemen---the importance being that the US has a huge drone program
resident in Yemen. The point here being
that both situations contain potentially explosive elements that could suddenly
have negative global geopolitical implications.
Update from
Ukraine (medium):
Putin’s
position (medium):
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. There was little economic data from the rest of the world this week
though the IMF did downgrade its outlook for global growth in 2015 and 2016.
More important,
(1) the continuing decline in oil prices keeps alive worries regarding their
ultimate impact on the global economy; though I reiterate nothing has happened
to date to give flesh to any of those concerns and (2) the Greek election on
Sunday brings the potential for a Greek withdrawal from the EU and defaulting
on their debts to the center of the table.
However, I don’t have a clue regarding the potential ripple
effects. That said, it is a risk that
can’t be ignored.
My point in all
this is that the aggregate risks incorporated in a faltering global economy I
believe is the biggest threat to our own economic health.
Bottom line: there was too little US economic news this
week to have much bearing on our forecast.
However, I think that the continuing trend of disappointing corporate
earnings reports should be viewed as a potential threat to our outlook---potential
being the operative word. The good news is that there is still nothing to
suggest that any negative fallout from a slowing world economy is at our door.
The QE dreamweavers
received more good news this week from the ECB, Canada, Denmark and Turkey. Ignoring for the moment the fact that there
is little evidence to substantiate QE as a workable policy, with virtually all
the global central banks, large and small, now pursuing the same easy money/currency
devaluation initiatives, the question is how are they going to accomplish
anything positive relative to other nations?
They are not, I think. What they
will do though is keep the speculators, hedge funds and carry traders well
supplied with cash to keep the current asset bubble expanding.
The key event to
which to pay attention is now the Greek elections and the economic/political
fallout that could occur as a result. I
have no idea what that will be but it almost certainly contains the risk of
disrupting the EU banking system.
This week’s data:
(1)
housing: the National Association of Homebuilders’
January index was flat; weekly mortgage applications rose but purchase
applications fell; December housing starts increased, but permits were down;
December existing home sales were up, in line.
(2)
consumer: weekly
retail sales were up; weekly jobless claims fell,
(3)
industry: the January flash manufacturing PMI was
slightly below expectations,
(4)
macroeconomic: the December leading economic indicators
were ahead of estimates.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17672, S&P 2051) had another highly volatile week, destroying
that pennant formation that I had been watching but still closing within
uptrends across all timeframes: short term (16450-19222, 1909-2290),
intermediate term (16479-21634, 1734-2448) and long term (5369-18860, 783-2083). For the moment, the only resistance/support
levels that I am watching other than the boundaries of the aforementioned
uptrends is the former all time highs (17986/2080) (resistance) and the mid
December low (17288/1970) (support).
Volume was down
on Friday; breadth deteriorated. The VIX advanced slightly, but confirmed the
break of its very short term uptrend. It
also bounced off its 50 day moving average and remained within its short term
trading range and intermediate term downtrend.
The long
Treasury bounced back above the lower boundary of its very short term uptrend,
negating Thursday’s break. It finished within
the remaining uptrends across all timeframes and well over its 50 day moving
average. If last Thursday was the best
that we are going to get by way of consolidation, then TLT clearly retains a
very strong underlying bid.
In a stab at
much needed consolidation, GLD was off slightly but remained within its very
short term uptrend, above the upper boundary of its short term uptrend, within
the intermediate term trading range and above its 50 day moving average. If this decline remains above the lower boundary
of its short term uptrend, then any bounce will likely prompt buying by our
Portfolios.
Bottom line: the
Market’s new found volatility continued this week. It has been wild and woolly enough that it
makes sense of widen our perspective particularly the distance element of our
discipline. So my focus is on the boundaries
of the indices’ uptrends as well as the former high and mid-December low.
GLD is behaving
very much like a bottom has been made. I
want to wait for the first downturn to see how that consolidation plays
out. If it holds trend boundaries, then
it will be time to Buy.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17672)
finished this week about 48.1% above Fair Value (11933) while the S&P (2051)
closed 38.3% 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 cloudy. While the reported economic data provided
little guidance, we have to assume that the US economy continues its sluggishly
improvement. The lousy earnings reports
from last week got a respite mid-week then continued with a vengeance on Friday
with disappointments from UPS and Kimberly Clark. I remain hesitant to extrapolate this trend. Clearly, we are still in the beginning stage
of this earnings season; so anything can happen. But I am worried that the inauspicious
beginning of this season may portend headwinds arising from (1) global economic
weakness and (2) the near universal acceptance of currency devaluation [QE] and
the negative impact that will likely have on the foreign profits of US
companies.
Overseas, there
was little economic information, though the IMF did lower its global economic
growth expectations for 2015 and 2016. However,
there was no shortage of international developments. QE led the list. Not just the long anticipated ECB QE; but a
land rush of other central banks climbing on the QE bandwagon: Canada, Denmark,
Turkey and to a lesser extent China.
My problem is
that I have yet to hear one of the dreamweavers point to one example of QE
success in creating jobs and economic growth as a rationale for their
action. Rather, these steps seem aimed
at competitive devaluations which unfortunately only work when you are the only
one doing it. Now that virtually
everyone is doing it, it looks the mirror image of the 1920’s Smoot Hawley
tariffs which were enacted to accomplish the same objective---beggar thy
neighbor. I have no clue how this plays
out; but when everyone is trying to punch their neighbor in the mouth, I can’t
imagine the outcome being all that good.
As if that weren’t
enough, (1) oil prices continue to fall---another trade related result of a
weapon [overproduction] being wielded by Saudi Arabia, (2) the US backed
government in Yemen [a major US drone base] has been overthrown by an Iranian
sponsored rebel group, (3) the Greeks vote on Sunday for a new government. Ahead in the polls is a party that has
threatened to exit the EU and default on its debt. While some of that may be political rhetoric,
it still poses potential problems to the EU financial system and (4) the
Russians and Ukrainians are at it again.
Like so much of the above, no one can project how this situation
ultimately gets resolved. But we do know
that the cutting off of oil to Europe is among the possible outcomes. Of course as I observe every week, so far
none of these negatives have showed up in the numbers---and may never. But the risks are still there.
However, even if
none of these prospective negatives materialize, valuations are still stretched
to extremes and the risk/reward equation at current prices levels makes no
sense.
Bottom line: the
assumptions in our Economic Model haven’t changed though the yellow light is
flashing. In addition, the risk to our
global ‘muddle through’ scenario is greater than ever as a result of the
continuing decline in oil prices, disruptions in the global monetary system and
a potential Greek exit from the EU.
The assumptions
in our Valuation Model have not changed either. I remain confident in the Fair Values calculated---meaning
that stocks are overvalued. As a result,
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 17672
2051
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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