3/28/15
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 (revised)
0-+2%
Inflation
(revised) 1.0-2.0
Corporate
Profits (revised) -5-+5%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 16858-19635
Intermediate Term Uptrend 16946-22097
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 1969-2950
Intermediate
Term Uptrend 1783-2541
Long Term Uptrend 797-2116
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 neutral for Your Money. The US
economic data this week was more mixed than it has been of late though the
primary indicators were largely negative: positives---month to date retail
chain store sales, weekly jobless claims, February new home sales, weekly mortgage
and purchase applications, March consumer sentiment and the March Markit
manufacturing and services flash PMI’s; negatives---February existing home
sales, the February Chicago National Activity index, February durable goods
orders, the March Richmond and Kansas City Fed manufacturing indices, fourth
quarter corporate profits and February CPI ex food and energy CPI; neutral---February
CPI, fourth quarter revised GDP.
The important
data points this week were new home sales (+), existing home sales (-), the
March Markit flash manufacturing and services PMI’s (+), the Chicago National
Activity index (-), fourth quarter GDP (0) and corporate profits (-) and
February durable goods (-). So the
negatives clearly outweigh the positives. Furthermore, existing home sales (a negative)
are roughly ten times the size of new home sales (a plus); and though fourth
quarter GDP was in line, corporate profit growth slowed further. Adding insult to injury, the Atlanta Fed reduced
its first quarter GDP estimate again (0.2%) and S&P cut its expectations
for first quarter earnings.
So overall, I
rate this week’s economic data as negative.
That said, having just downgraded our forecast, I don’t want to appear
to be minimizing the positive news that we received. They were a hopeful sign especially after
weeks on nothing but negatives. But still
two primary positives in a week of eight negatives is just barely hopeful, if
at all. Plus, at the moment they are
just outliers and will only matter if the numbers we get in coming weeks also
show improvement.
There were few
international stats and they were mostly negative: one upbeat datapoint was the
EU March Markit flash composite PMI which came in near a 46 month high; but the
China March manufacturing index showed contraction, global trade was at its
lowest level since Lehman and Japanese inflation was zero. In addition, we learned that the large
Chinese banks are cutting their dividends due to increasing bad debts and the
second largest bank replaced its chairman accusing him of taking too much risk.
In addition, a Greek
bailout is anything but assured. To be
sure, the parties are still talking. But
some of the most knowledgeable experts are giving 50/50 odds of a Grexit to
which there are bound to be unintended consequences. While the direct economic fallout is likely
not all that great to the EU or global economy, I would like to know those unintended consequences before
dismissing this as a minor nuisance.
Our forecast:
‘a below average secular rate of recovery,
exacerbated by a declining cyclical pattern of growth, 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. Oil supplies remain abundant and that is a
significant geopolitical plus. Furthermore,
lower prices should be constructive when viewed as either a cost of production
or cost of living. However, none of pricing
positives have yet shown up in the macroeconomic stats. Indeed, as I have been pointing out, that
data only gets worse the further oil prices fall.
That said, the
price of oil was up meaningfully in the last six days of trading. Were it to continue, the question becomes,
since lower oil prices led to lousy economic data will higher oil prices lead
to an improvement?
The problem that
I am concerned about is the impact lower oil prices [employment, rig count,
cash flow] have had on the subprime debt from the oil industry on bank balance
sheets and the likelihood of a default.
The
negatives:
(1) a
vulnerable global banking system. This
week, the stories were:
(a) more
financial gimmickry from the too big to fail banks [see link below]. By the way, this is the same ruse they used
in 2008 to hide the loses in their mortgage portfolios and remain ‘solvent’ on
a GAAP basis---the magnitude about which, I might add, neither we nor the
regulators still have a clue.
(b) trouble
in China as banks cut their dividends and officers are being replaced as a
result of a significant rise in bad debts.
(c) that
failed Austrian bank we have been following potentially claims another victim (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. Miracle of miracles, congress
actually passed a budget; and even better, it is being touted as reducing
spending by $5 trillion over the next ten years. I have yet to see its exact
provisions or any evaluation of the probability of those provisions really
cutting spending. So for the moment, I am withholding judgment but with a
positive attitude.
In making that judgment,
there are a couple of things to remember: (1) cutting spending is not the same
thing as reducing the budget; that is, if spending was expected to rise by $20
trillion, then a $5 trillion cut, while a start, is not as impressive, (2) one
of the most popular accounting gimmicks of the political class when they
trumpet spending cuts is to make the majority of those reductions in the out
years; in this case in other words, there may be very little reduced spending
in the current year but a lot in year 10---which usually gets altered by the
then sitting congress, (3) it is easy to project lower spending or increased
revenues that have little probability of occurring, and (4) perhaps even more
important, it is easy to legislate spending cuts that you know Obama will veto.
I don’t want to
give the impression of being dismissive of this development. It seems a worthy start towards spending, tax
and regulatory reform. However, I would
like to see the accounting in the bill and it signed before getting too jiggy.
(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.
We actually
made it through a whole week without some central bank driving for the
competitive devaluation hoop---which in no way negates the risk of economic
dislocations that have historically accompanied multi country beggar thy
neighbor policies.
It is also not
to say that there was no news on QE or its effects. In Japan, February inflation was reported at
zero. Which begs the question, Mr. Abe
how is that money printing working out for you? Clearly another solid piece of evidence that
QE hasn’t and isn’t working.
Meanwhile in
China the aforementioned dividend cuts and firings reveal yet another negative
consequence of cheap money and easy credit.
And here is yet
another---capex declining while stock prices rise (short):
Finally on
Friday afternoon, Yellen gave a speech in which she sounded more upbeat on the
economy (i.e. more hawkish on an interest rate increase) than the statement and
the press conference following the last FOMC meeting. While somewhat confusing on the surface, I
think that this was just smoke to hide the fact that she knows that the economy
is slowing (she said as much after the FOMC meeting) but doesn’t want to
emphasize that too much for fear that concerns over a potential recession and
falling corporate profits will spook the Markets---which after all has been the
Fed’s primary focus for six years.
Forget the
federally mandated dual objectives of employment and inflation. Those goal posts have been moved around
several times since 2008 just to accommodate QE. The one thing the Fed has lived in mortal
fear of is crushing the asset bubble that it has created. When the economy was improving, the Fed was
dovish on raising interest rates so that Markets wouldn’t be concerned about
higher interest rates (a higher discount factor/lower PE); now the economy is
slipping, it wants investors to believe that it is so strong that a rate hike
is around the corner so the Markets won’t be worried about a recession
(declining corporate profits).
Yellen lifts
her skirt (short):
In short, QE is
not working anywhere including the US despite its implementation on an
intergalactic scale.
(4) geopolitical
risks. The saber rattling continued in
Ukraine and has now moved to the stage of troop movements and naval
exercises. I continue to believe that no
one in NATO or the White House has the balls to stare down Putin. The risk is stupidity.
The Middle East
is heating up, most notably in Yemen where the Saudis and Egyptians [Sunni] are
now actively fighting the Houthis rebels [Shi’a]---creating the potential of a
regional Sunni/Shi’a military conflict. I
have said before that we just ought to wall the region off and let them the
destroy each other. Which I think is a
better alternative than our current inept management of Middle East policy [at
odds with our best ally, fighting Sunnis in Iraq and Shi’a in Yemen]. I don’t see any upside to present
policy. On the other hand, the downside
to that is what happens to all the oil fields---though the question is, can
they be saved under any circumstance if all-out war breaks out. One final thought, the Russians and Chinese
haven’t chosen sides yet---though Russia is becoming increasingly involved.
In addition, …I am…concerned about the lack of
appreciation by our leadership of radical Islam’s intent to bring the war to
our home. My fear is that it will take a
major catastrophe [like burning people alive and mass beheadings aren’t enough]
to make Our Glorious Leader 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. There were few global economic stats this week;
and while most were negative, we did get one bright spot [EU composite
PMI]. Coupled with the mixed report two
weeks ago, some might argue that we may be seeing a slowdown in the rate of
deterioration. I don’t think so; and
even if we give this notion the benefit of the doubt, it is still too soon to
know.
Not helping
matters is the uncertainty surrounding the Greek bail out. Granted, the negotiations continue and the
Greeks are expressing the desire to reach terms agreeable to the Troika. But we have seen this routine before only to
be followed by distinctly combative rhetoric out of the Greeks. In addition, individuals that I consider knowledgeable
are giving the odds of a Greek exit at 50/50.
Were it to occur, I am less worried about its impact on the global
economy and more about the effect on the EU financial system as well as unintended
consequences. I am not saying that there
is a huge price to pay. I am saying I
don’t know and I don’t think anyone else does either.
And: Greeks prepared for ‘riff’ (medium):
‘Muddling
through’ remains the assumption in our Economic Model; but I believe that time
is running out, particularly on the economic policies of the EU. This remains the biggest risk to forecast.
Bottom line: the US economic news was lousy for a ninth
straight week. Estimates are being
lowered for economic and profit growth, though no one has yet uttered the ‘r’
word. However, I am feeling more
comfortable with our downwardly revised forecast.
The global
economy may have reached a stage where it is no longer deteriorating; but it is
too soon to know. The central banks
continue to print money as fast as they can run the presses with no evidence
that it is working as assumed. The only
good news is that no one upped the rate cut ante this week.
My immediate concern is that these actions
add fuel to the currency devaluation race---the history of trade wars generally
suggest that they don’t end well. Further, I believe that the ultimate price
for the largest expansion in global monetary supply in history will be paid by
those assets whose prices have been grossly distorted, not the least of which
are US equity prices.
Geopolitical
events took center stage this week as (1) the Greeks and the Troika attempt to
come to terms on a bailout plan, (2) the shouting war between NATO and Russia has
moved up a notch as troop movements and naval exercises have been launched and
(3) the Middle East is inching closer to Sunni/Shi’a civil war which almost
certainly won’t leave oil supplies unscathed.
This week’s
data:
(1)
housing: February existing home sales were up one half
of estimates while new home sales rose twice that anticipated; weekly mortgage
and purchase applications were up,
(2)
consumer: month
to date retail chain store sales were up slightly; weekly jobless claims
declined more than consensus, March consumer sentiment was above expectations,
(3)
industry: the February Chicago National Activity index
was very disappointing as was February durable goods orders; both the March
Markit manufacturing and services flash PMI’s was better than estimates; the
March Richmond and Kansas City Fed manufacturing indices were well below
forecasts ,
(4)
macroeconomic: February CPI was in line though ex food
and energy it was a bit hotter than consensus; final revised fourth quarter GDP
was unchanged but below expectations, the price deflator was in line and
corporate profits were up 2.9% versus 5.1% in the third quarter.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17712, S&P 2061) closed Friday on an up note in a down week. They remained well within their uptrends across
all timeframes: short term (16858-19635, 1969-2950), intermediate term (16946-22097,
1783-2541 and long term (5369-18860, 797-2116).
During the week,
both successfully challenged their 50 day moving averages; and (1) the Dow also
broke its 100 day moving average but the S&P did not and (2) the S&P
broke the lower boundary of its very short term uptrend but the Dow did not.
Volume fell on
Friday; breadth improved. The VIX was down, closing within its short term
trading range, its intermediate term downtrend, its long term trading range,
below its 50 day moving average and within a developing pennant formation. I continue to think that, at these prices, it
represents cheap insurance for the trader.
The long
Treasury rose, but not enough to regain the lower boundary of its very short
term uptrend, negating that trend.
However, the good news is that its recent advance firmly broke the
initial sell off from the high. It
finished within its short term trading range, intermediate and long term
uptrends and above its 100 day moving average. The failure to recapture its
very short term uptrend notwithstanding, it still appears more and more like
its chart has stabilized.
GLD’s price fell
Friday, wrapping up a generally positive week.
However, it still closed within its short and intermediate term trading
ranges, its long term downtrend and below its 50 day moving average. The bright spot is that it is no longer in a
very short term downtrend. That said,
GLD still has a lot of work to do before its chart gets healthy.
Bottom line: the
indices ended the week with a confusing short term technical picture as both were
battling their 100 day moving averages and the lower boundaries of very short
term uptrends. However, longer term,
they remain firmly in uptrends across all timeframes---and there is nothing
confusing about that.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17712)
finished this week about 48.0% above Fair Value (11966) while the S&P (2061)
closed 38.6% 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 US economic
numbers were mostly negative side, though there were a couple of upbeat reports.
However, the Atlanta Fed lowered its
first quarter GDP forecast again (now +0.2%) and S&P earnings growth
estimates for the same period are dropping towards zero. In sum, nothing here to make me second guess
last week’s revised forecast. Therefore,
nothing that would alter our Valuation Model.
The global
economic news was also negative save for one upbeat stat. Perhaps more important, the geopolitical
environment worsened noticeably: (1) odds
of a Greek exit of the EU have gone to 50/50 by some informed observers, (2)
the standoff between Russian and NATO over Ukraine continues to go downhill,
and (3) the Middle East is turning into internecine Islamic food fight, only
the projectiles are new potatoes.
Foreign policy isn’t my long suit; so I am unsure how to score the true
likelihood of a major economic/political dislocation arising from any of the
foregoing. But I suspect the odds aren’t
zero. Hence, the risks remain to the
global economy and securities markets.
In addition, I
have no clue how to quantify the aforementioned geopolitical risks’ impact on our Models even if I could place
decent odds of their outcome because: (1) the outcomes are mostly binary, i.e.
Greece either exists the EU or doesn’t and (2) they all most likely incorporate
potential unintended consequences, which by definition are unknowable. Better to just say these are potential risks
with conceivably significant costs and then wait to see if we ‘muddle through’
or have to deal with those costs. The
important investment takeaway, I believe, is to be sure that your portfolio had
at least some protection in the downside.
The global
central bankers were relatively quiet this week with no one raising the ante on
easy money/lower rates. Which is
probably irrelevant anyway since (1) the aforementioned developments in Japan
and China again confirm the ineffectiveness of QE and (2) the current
imbalances in the financial markets are so enormous that the ultimate unwinding
of QEInfinity will be painful enough without more of the same. As for our own Fed, it has once again failed
to manage the transition from easy to normal monetary policy properly. How badly the economy and financial markets will
pay for this high priced incompetence is yet to be known. But I believe that this malpractice will
prove to be very expensive.
As you know, I
have adjusted our Economic Model to account for economic issues discussed
above; and, as you also know, they will have little to no impact on our
Valuation Model since it uses long term moving averages for these inputs. On
the other hand, if I am correct and economic and corporate growth estimates
start coming down on the Street, that will almost assuredly generate heartburn
for many whose valuation models are tied to forward looking data---and that
will undoubtedly have an impact of security prices.
Bottom line: the
assumptions in our Economic Model have changed.
While they will have no effect on our Valuation Model, if I am correct
they will almost assuredly result in changes in Street models which will have
to bring their consensus Fair Value down.
The assumptions
in our Valuation Model have not changed either; though there are scenarios
listed above that could lower Fair Value. That said, our Model’s current calculated Fair
Values are so far below current valuation that any downward revisions by the
Street will only bring their estimates more in line with our own.
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.
Explaining
the stock and bond markets (medium):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 3/31/15 12003 1491
Close this week 17712
2061
Over Valuation vs. 2/28 Close
5% overvalued 12603 1565
10%
overvalued 13203 1640
15%
overvalued 13803 1714
20%
overvalued 14403 1789
25%
overvalued 15003 1863
30%
overvalued 15603 1938
35%
overvalued 16204 2012
40%
overvalued 16804 2087
45%overvalued 17404 2161
50%overvalued 18004 2236
55%
overvalued 18604 2311
Under Valuation vs. 2/28 Close
5%
undervalued 11402 1416
10%undervalued 10802 1341
15%undervalued 10202 1267
* 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.
