The Closing Bell
2/21/15
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 16630-19402
Intermediate Term Uptrend 16677-21832
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 1932-2913
Intermediate
Term Uptrend 1757-2471
Long Term Uptrend 797-2095
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 53%
Economics/Politics
The
economy is a modest positive for Your Money. The US
economic data this week again weighed to the negative side: positives---month
to date retail chain store sales, weekly jobless claims, the minutes from the
last FOMC meeting; negatives---weekly mortgage and purchase applications, January
housing starts and building permits, February homebuilder confidence, the
February NY and Philadelphia Fed manufacturing indices, January leading
economic indicators, January industrial production and capacity utilization,
January PPI; neutral---none.
The key numbers
were housing starts, industrial production and the leading economic indicators---all
demonstrating weakness and making this the fourth consecutive week of subpar
reports among primary indicators. This
puts the recent data flow on the cusp of redefining a trend. However, we have been through so many
instances in the current recovery in which a period of lousy data was suddenly
followed by improvement, I am more hesitant to dub the current situation as the
likely beginning of a slowdown than I might otherwise be. Making this more complicated is that February
stats are bound to reflect the negative impact of the west coast longshoremen’s
strike as well as the terrible weather the eastern portion of the country has
suffered. So interpreting the economic
tea leaves over the next six weeks is going to be very tricky. This makes me very cautious about changing
our forecast: but the yellow light is flashing brighter.
Greece dominated
this week’s headlines---deal, no deal, deal, no deal--- culminating with a deal
(I think). The short version is that the
Greek’s folded like cheap umbrella; and the bottom line is (1) that the euros
did what they do best [kick the can down the road], (2) but that means our EU ‘muddle
through’ scenario is intact, (3) it removes a potential Greek default as a
major risk to our economic forecast---at least for the moment and (4) serves to
re-focus our analysis to the key element of that outlook---the current string
of key US economic indicators signaling of an impending economic slowdown in
the US.
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 hesitant 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. I want to be clear about something. Greater domestic supply of energy is and
always will be a major long term positive, in that it gives the US greater
control [less dependence on foreign oil] of a major component of
production.
The debate of
late has been about energy prices---which is a shorter term
issue. And the problem has been that no
one is winning the debate; that is, it is not clear if lower oil prices have
been a plus for the overall economy as the consensus would have us believe. In fact the opposite is true---economic stats
have been worsening as oil prices have fallen.
I am not trying to draw a causal relationship here; but clearly a
weakening in economic numbers at the same time that oil prices are falling is
causing the ‘unmitigated positive’ crowd fits.
I leave open the question as to whether lower oil prices are a plus for
the economy until we have either more evidence or better analysis or both.
However, what
we do have solid data for, is the negative impact lower oil prices are having
within the oil patch. And it is along
those lines that I have concerns, specifically the magnitude of the subprime
debt from the oil industry on bank balance sheets and the likelihood of a
default. Although here too, there is little
to substantiate a problem; just speculation about the potential danger.
The
negatives:
(1) a
vulnerable global banking system. No new
accusations, investigations or subpoenas this week; but the WSJ reported late
Friday that Deutschebank and Banco Santander will likely fail a US bank stress
test largely based on inadequate supervision of massive derivatives positions.
http://www.zerohedge.com/news/2015-02-20/are-two-big-problems-deutsche-bank-failing-feds-stress-test
‘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. Our ruling class is on another
much deserved vacation this week.
(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.
This only gets
worse. Japan announced this week that it was so proud of its quadruple in, swing
for the fence, balls to the wall, give
me liberty or give me death ‘beggar thy neighbor’ monetary policy, that it wanted
to reassure the world that it was not about the quit. And our own beloved Fed mewed demurely about
how it couldn’t possibly raise rates by a whopping 0.25% because it simply
doesn’t have enough information to suggest such a move wouldn’t cause an
economic crash. Of course, [a] an
economy can’t crash when it cruising at an altitude of one foot and [b] it
isn’t the economy these guys are worried about in the first place---it is the
extraordinarily mispriced asset markets.
And they should be worried. But
let’s not confuse the issue: it isn’t the economy that will cause us problems;
it has benefitted very little from QE’s and so I doubt it will be hurt by their
absence.
Draghi likely
to have problems implementing his own version of QE (medium):
(4) geopolitical
risks. Putin appears to have the
Ukrainian conflict under control after a little help from Merkel. That is not to say that all is quiet on the
western front, but Ukraine does seem to be diminishing as potentially major
negative event.
The Middle
East, however, so f**ked up, I don’t think anyone has a clue as to how it will
play out. God only knows that US foreign
policy would be better off if we didn’t even have a president or a secretary of
state right now. My fear is that it will
take a major catastrophe [like burning people alive and mass beheadings aren’t
enough] to make these morons realize how irresponsible, unsound, dangerous and
intellectually vacuous our current ‘local law enforcement’,’ jobs for
jihadists’ strategy [?] is.
(5) economic difficulties, overly indebted
sovereigns and overleveraged banks in Europe and around the globe. This week
was another of mixed data from overseas---though this time the encouraging data
came from both Japan and Europe. While
only the second week of ‘less bad’ data, it does raise the potential hope that
the heretofore steady stream of negative global economic indicators might be ameliorating. However, puking all over that notion, Goldman
released a study on Thursday evening covering global economic activity [clearly
far more comprehensive than my efforts] in which it reports that the
international leading economic indicators are pointing at a decline in
growth. That carries more weight than
one or even a couple pieces of upbeat data.
On the other hand, I can’t completely ignore those better reports. So for the moment, I am keeping a global
slowdown as the biggest risks to our forecast but with a little less certainty
on my part.
Every time I
report something new on the Greek/EU bailout negotiations, the opposite happens
before the ink is dry. But I am sure
this time is different--- the Greeks and the EU reached a tentative agreement
Friday afternoon. The terms provide for
a four month extension of the bailout funding for the Greek government, PROVIDED
the Greeks submit a detailed plan on reform measures by Monday AND it is
approved by EU/ECB officials.
On the surface,
it appears to be capitulation by the Greeks.
However, a lot of water is going to run under bridge back home between
now and Monday and most of it will be focused on those two conditions above [a detailed
plan that basically follows the old agreement that the Greeks have already rejected
and its approval by the officials that have so rankled the Greeks to date].
If you assume that
the Greeks comply, it will keep the EU ‘muddling through’ scenario intact---more
or less in line with our forecast. Hence,
I view this less as a big positive and more as lowering the near term risks of a
big negative.
Of course, we
will know more Monday as to whether the Greeks really and truly did
surrender. Unfortunately, even if they
did, it will only make the arithmetic of more austerity and more debt
ultimately more unworkable than it is now.
We may be only in the second rather than the fourth act of this tragedy;
but there will still be a final curtain.
And unless something truly revolutionary takes place in EU fiscal and
monetary policy, the economically unsustainable position of Greece and many of
the other PIIGS will have to be reconciled---and that process is apt to be
painful, more so the longer it takes to resolve.
The text of the
agreement (medium):
Analysis
(medium):
And:
Bottom line: the US economic news was lousy for a fourth
straight week which keeps moving our forecast further into ‘at peril’
territory. I am not making changes at
this time because (1) we have seen this pattern in the current recovery before
only to have it followed by a jump in activity, (2) international economic
stats were mixed for a second week in a row---though the new report out of
Goldman may be a stake through the heart of any chance of global economic
improvement and (3) earnings season is turning out less bad than first
appeared. Nonetheless, the yellow light
is flashing brighter.
Easy money
received a boost this week from Japan and our Fed---even though there remains
scant confirmation that QE anywhere, anytime [except QEI] has done a lick of
good. Because of that, I am not all that
worried about an unwind of QE. Rather I am
more concerned about the consequences of a continuation of the policy
especially as it relates to currency policy [‘beggar thy neighbor’] and its
ultimate impact on global economic activity.
The negotiations
between the Greeks and the EU/ECB seems to have yielded fruit at least for the
short term (‘seems’ being the operative word at this moment). If so, then Greece and the horrible state of its
economy and finances get downgraded on our risk scale---again, at least in the
short term.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
off markedly; January housing starts and building permits were much lower than
estimates; February homebuilder confidence was lower than anticipated,
(2)
consumer: month
to date retail chain store sales improved; weekly jobless claims dropped more
than consensus,
(3)
industry: the February NY and Philadelphia Fed
manufacturing indices were below expectations; January industrial production
and capacity utilization fell short of forecasts,
(4)
macroeconomic: the January leading economic indicators were
below expectations; January PPI was worse than estimates; the minutes from the
last FOMC meeting had a slightly more dovish tone than the statement issued
after the same meeting.
The Market-Disciplined Investing
Technical
The
indices (DJIA 18140, S&P 2110) traded relatively quietly for most to the
week then had a blow off Friday. They
remained well within (or above) their uptrends across all timeframes: short
term (16630-19402, 1932-2913), intermediate term (16677-21832, 1757-2471 and
long term (5369-18860, 783-2083). Both ended
above their 50 day moving averages and their mid-December all-time highs. The S&P finished above the upper boundary
of its long term uptrend for the fourth day.
If it closes above that level on Monday, the break will be confirmed. However, under our trading discipline, the
Averages have to be in sync to signal a change in trend; and the Dow still has
700 point to reach the upper boundary of its long term uptrend.
Volume was up on
Friday (option expiration); breadth was strong but not as much so as I would
have thought, given the pin action. The VIX was down, below its 50 day moving
average and within its short term trading range and intermediate term downtrend. I am not a trader; but if I were, at these
prices I could buy portfolio protection pretty cheap.
With both
Averages above their December highs and the S&P above the upper boundary of
its long term uptrend, I ran two studies on our internal indicator. (1) looking at stocks at or above their long
term highs: in a 141 stock Universe, 46 stocks were above their all-time highs,
10 were right on those highs and 85 weren’t close, (2) looking at stocks at or
near the upper boundaries of their long term uptrends: in a 141 stock Universe,
26 were at or near their upper boundaries, 29 were above their all-time highs
but not close to their upper boundaries and 85 weren’t close.
Note: the
seeming discrepancy in the math is that some stocks are in what at first glance
appears to be two inconsistent categories; for example, a stock might have
traded above the upper boundary of its long term uptrend, made a new high then
backed off sufficiently to be materially below that all-time high but still
above its long term uptrend. Hence it
would be counted as a stock that is above its long trend but is nowhere near
its all-time high.)
The long
Treasury suffered some more whackage this week but, at least, appeared to be
attempting to stabilize. The bad news is
that it finished below its 50 day moving average and the lower boundary of its
short term uptrend (for the second day) and within a developing very short term
downtrend. If it closes below the lower boundary
of its short term uptrend on Monday, the trend will re-set to a trading range. The
good news is that TLT remains well within intermediate and long term uptrends. Any move down toward these levels will likely
prompt our ETF Portfolio to Add back those share Sold last week.
GLD ended right
on the lower boundary of its short term uptrend and below its 50 day moving
average. If it trades lower, then the
remainder of our Portfolios’ positions well be Sold. However, a solid bounce off the short term
lower boundary could be cause for buying back those shares Sold week before
last.
Bottom line: the
pin action this week shifted the momentum to the upside with the S&P very
near breaking above the upper boundary of its long term uptrend. That would almost assuredly set the stage for
a further advance; though the lack of confirmation by the Dow as well as the
abysmal reading from our internal indicator pose negatives. While I don’t believe that the fundamentals
justify higher prices---that is just my opinion. On the other hand, if stocks do trade higher,
our Portfolios will continue to use that opportunity to Sell stocks that no
longer fit our investment criteria or those which trade into their Sell Half
Range.
TLT and GLD seem
to be trying to stabilize. At the
moment, our Portfolios are simply holding their positions. That could change depending on the pin
action.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (18140)
finished this week about 51.2% above Fair Value (11966) while the S&P (2110)
closed 41.9% overvalued (1487). 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.
This week’s economic
stats darkened the overall investment picture.
We now have four consecutive weeks of subpar US dataflow. Because there has been a recurring pattern in
this recovery of a period of weak economic numbers followed by improvement, I am
prepared to let this go on a bit longer before altering our forecast. Indeed, the numbers are almost certain to
remain subpar as the effects of the west coast longshoremen’s strike and the
disruptive January/February weather pattern work their way through the economy.
That said, as I have
explained before, any downgrade in economic activity will have very little
impact our Valuation Model since I use moving averages for many of our inputs. On the other hand, a slippage in profit growth
will almost certainly effect Street psychology and the forward earnings
estimates investors love so much.
If you are a QE
devotee, the skies brightened this week with Japan quadrupling down on QE and
our Fed sounding more dovish than anticipated in the minutes of its latest FOMC
meeting. As you know, while I acknowledge
the very positive impact of QE on asset prices to date, I am far less sanguine
going forward because (1) QE has caused excesses in the financial system that sooner
or later will have to be rectified; and the greater the excess, the more
painful the correction (2) QE is morphing into a global currency war which has
never been good for economies or markets.
At this moment,
consensus is that the Greeks have folded their tent and gone to the house. That may be a bit too pat; but I am tired of
arguing over the risk of no resolution. I
would rather bottom line what this would mean for our Models---and that is:
nothing. A settlement would clearly remove a potentially large negative from my
list of worries. But our basic
assumption always has been and remains that Europe would ‘muddle through’ as it
has for the past decade.
Then why did I spend a lot of time and ink developing
this subject? Because (1) I don’t think the
Greek (PIIGS) model is sustainable long term in a fiscally unreformed EU, (2) I
thought the new Greek regime had bigger balls than is now apparent and (3) that
was a combo that had a decent probability of leading to the painful but
inevitable rationalization of the current unworkable EU monetary/fiscal regime. Clearly I was wrong. On the other hand, I don’t want to minimize
my belief that barring a rewriting of the EU constitution, there will ultimately
be pain incurred as result of correcting the economic problems being created by
a monetary but no fiscal union---a lot of pain.
But that is for
another day. Today, we rejoice that the
ruling class is doing what it does best which is to totally f**k things up and
then kick the problem down the road. Today, we worry not about a Greek default
which never happened and wasn’t in our forecast anyway; we worry about the
lousy numbers from our economy and from the global economy.
I guess that we
can rate the resolution of the Ukrainian violence as a plus. While clearly a victory for Putin, it at
least takes a military confrontation between the US and Russia off the table.
It seems daily
that ISIS becomes stronger, spreads geographically and pushes the envelope on
atrocious behavior. Given that it almost
assuredly views these developments a major positives, I don’t see how this
stops until somebody or somebodies kick the living shit out of these guys----as
opposed to, you know, finding them jobs.
I don’t claim to have a strategy; but I do fear that their violence will
only get worse and get closer to home in its absence.
Bottom line: the
assumptions in our Economic Model haven’t changed though the yellow light is
flashing as a result of (1) a four week string of disappointing US stats, (2)
only marginal improvement the flow of global economic indicators and (3) the
relentless pursuit of QE which is creating the conditions for a currency war.
The assumptions
in our Valuation Model have not changed either. I remain confident that the Fair Values calculated
are so far below current valuation that it would take the second coming of
Jesus for stocks to have even a remote chance of not reverting to Fair Value. 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.
The
problem with using forward earnings in valuing stocks (medium):
Deutschebank:
0% upside (short):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 2/28/15 11966 1487
Close this week 18150
2110
Over Valuation vs. 2/28 Close
5% overvalued 12564 1561
10%
overvalued 13162 1635
15%
overvalued 13760 1710
20%
overvalued 14359 1784
25%
overvalued 14957 1858
30%
overvalued 15555 1933
35%
overvalued 16154 2007
40%
overvalued 16752 2081
45%overvalued 17350 2156
50%overvalued 17949 2230
55%
overvalued 18547 2305
Under Valuation vs. 2/28 Close
5%
undervalued 11367 1412
10%undervalued 10769
1338
15%undervalued 10171 1263
* 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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