The Closing Bell
3/7/15
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 16721-19492
Intermediate Term Uptrend 16795-21946
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 1949-2930
Intermediate
Term Uptrend 1768-2482
Long Term Uptrend 797-2112
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---weekly mortgage
applications, the February manufacturing PMI, the February ISM manufacturing
index, the latest Fed Beige Book report and February nonfarm payrolls;
negatives---weekly purchase applications, weekly retail sales, January personal
income and spending, February light vehicle sales, weekly jobless claims,
January factory orders and January construction spending; neutral: the February
ADP current and revised private payrolls report combo and fourth quarter
current and revised nonfarm productivity combo; the January trade deficit.
The key numbers
were the February ISM manufacturing index, February nonfarm payrolls, January
personal income and spending, January factory orders and January construction
spending. So in total the numbers were negative and among the primary
indicators, they were also negative (3 to 2).
Many will hail the nonfarm payroll figure as the most important by far
but that is most likely because the Fed watches that number. However, (1) jobs are a lagging indicator, so
it says less about what is going to happen and more about what just happened,
(2) the internals of the report were not that great---the labor participation
rate is a short hair away from an all-time low and wage rates are not
suggestive of a healthy labor market and (3) even if you count it as a plus for
the economy, it is a negative for Fed policy [read the Market], in that it
increases the likelihood of a rate rise sooner rather than later.
Not helping
matters, the international dataflow turned negative again after a two week
respite. Of course, we won’t know if the
recent improvement was just an outlier or the beginning of a more positive
trend until more stats are in. But for
the moment, I have to go with the former.
This puts the recent data flow ever closer
to redefining a trend. However, as I
continually note, 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 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.
The Fed also
released the results of the latest bank stress test in which all those banks
that were measured passed. That is not
particularly surprising. However, what
makes the test less than useful is that the Fed avoided making any assumptions
regarding the potential for counterparty defaults in the banks’ derivative
portfolios---which was a major contributing factor in the last financial crisis.
Also of interest
is the latest Fed Beige Book report which was generally upbeat but much at odds
with the dataflow for the last six weeks.
Coincidentally, that is the exact period measured by the Beige Book. Many may argue that the Fed’s numbers are
the more important in measuring economic activity to which I would counter that
the Fed was insisting that there were no problems in 2008 right up to the point
that we fell off the cliff. My vote goes
to the anecdotal evidence.
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. 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 has gotten worse over the last month.
In addition,
prices spiked twice this week and on both occasions, stocks suffered severe
whackage. So while one’s intuition may
be favorably disposed to the ‘unmitigated positive’ notion, the opposite has
occurred in both the economic dataflow and stock prices.
There is also
another problem and that is the negative impact lower oil prices are having
within the oil patch [employment, rig count].
In that regard what has me worried is the magnitude of the subprime debt
from the oil industry on bank balance sheets and the likelihood of a
default. However, even in this case,
there is little to substantiate a problem; just speculation about the potential
danger.
Now we have our
first example (medium):
And just wait
until first quarter earnings are reported (medium):
The
negatives:
(1) a
vulnerable global banking system. This
week an Austrian bank announced a significant capital shortfall.
Other items of
interest:
Shadow banking liquidity plunging
(medium):
The lack of
prosecution of bank criminals (medium):
http://www.nakedcapitalism.com/2015/03/bill-black-question-bank-ceos-criminals-no-sense-decency.html
JP Morgan still
at it (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.’
Like this except that it’s the
corporations that have lost confidence (medium):
(2) fiscal
policy. This week, our ruling class squabbled
over funding for the Department of Homeland Security. In other words, nothing to solve our real
problems of too much spending, too high taxes and too much regulation.
(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 week Australia
and the ECB left interest rates unchanged while India lowered its key rates for
the second time in two months. In
addition, the ECB announced the terms of its new and improved QE, to wit, it
will begin a E60 billion monthly purchase of EU government and eurozone based
agency marketable bonds. The program
will last until September 2016 unless it fails to achieve its
growth and inflation objectives [2% growth, 1.5% inflation] in which case the
program will be extended indefinitely.
I have no doubt
that the ECB will just as successful in achieving the aforementioned economic
growth and inflation goals as everyone else who has attempted this monetary
policy strategy---in other words, there is close to a zero probability of
victory. Which in turn means EU QE can
go on for who knows how long.
Unfortunately, the
only goal this is likely to accomplish is to assist in the further misallocation
and mispricing of assets and aggravate the current trend in competitive
currency devaluation.
The Fed has
lost control (medium and a must read):
(4) geopolitical
risks. The saber rattling continues in
Ukraine as NATO commits troops to Ukraine and threatens additional sanctions
while Putin warns that Russia will shut off gas to Ukraine and parts of western
Europe. While there may be some small
danger of a shooting war [which surely our ruling class will avoid], the more
likely economic risk comes from a slowdown/recession in the EU brought on by
the ratching up of more sanctions and/or the cut off of gas supplies to Europe.
The Middle East is nothing but murderous
chaos. Although I am much less worried
about who is killing who over there and more worried 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. While we
continued to receive some positive economic stats from the rest of the world,
the dataflow in totality turned negative again this week. This makes the question, ‘were the numbers
from the prior two weeks outliers or the signal of an improvement in the global
economy?’ all the more difficult to discern.
All we can do is wait for data confirming one or the other alternative;
but clearly on the surface, a return to lousy numbers is not a plus---which
leaves a global slowdown as the biggest risks to our forecast.
Greece managed
to remain below the radar again this week, which is a big positive. However, below the surface rumblings
continue. We will know more on Monday
when the specifics are due for Greek proposals for meeting the Troika’s
guidelines in order to receive its bail out funding. As you know, I am convinced that a plan to
pay off current debt by enacting fiscal policies that inhibit economic growth
in order to receive yet more new debt is not a viable long term strategy for
economic improvement. Something has to
give in the way the eurocrats run the eurozone; and until more economically
sound fiscal, monetary policies are authorized, we are going to face the
probability of a default every time the rollover of bailout debt occurs. ‘Muddling through’ will continue until it no
longer can. Then, we got problems.
Bottom line: the US economic news was lousy for a sixth
straight week. Plus (1) Goldman and the
Atlanta Fed are both forecasting a slowdown in economic growth and (2) the
international dataflow turned negative following two weeks of ‘mixed’ stats.
Complicating the issue is the likelihood of the longshoremen’s strike and the
lousy weather having a very short term negative effect on the data. Indeed, we are already hearing these as
excuses for poor economic/earnings performances. So navigating the data and trying to separate
the cyclical components from the strike/weather related effects over the next
six weeks is going to be difficult. I
have not yet decided to change our economic forecast though I am very close to
moving it from a ‘modest positive’ to ‘neutral’. The yellow light is flashing brighter.
The easy money crowd
got more good news this week as Australia and the ECB held rates unchanged and
India lowered its key interest rates.
More important, the ECB announced the terms of its new and improved QE
program, which will only keep the asset pumping, competitive devaluation forces
going full blast. As you know, 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.
While Greece has
been sailing below the radar lately, it does have a meeting with EU/ECB/IMF
officials coming up in which it will present firm proposals on how it will
implement the terms imposed by the bailout agreement. The first stab at this came Friday afternoon;
and it seems a long way from meeting the standards laid out by the Troika. This may put Greece and the risk of default
back in the headlines; though it is too soon to know.
The economic
risks of the Ukraine/Russia standoff continue to grow as NATO threatens more
sanctions and Russia warns of shutting off gas to western Europe---a
development that would play merry hell with the EU economy and by extension
those of its major trading partners.
I have no idea
how the Middle East conflict gets resolved; but I fear another 9/11 like attack
on the US.
This week’s
data:
(1)
housing: weekly mortgage rose but purchase applications
declined,
(2)
consumer: month
to date retail chain store sales slowed;
January personal income and spending [it fell] were below expectations;
February light vehicle sales were disappointing; the February ADP private
payrolls report was below forecasts, however, the January number was revised up
big time; February nonfarm payrolls were well over consensus; weekly jobless
claims were disappointing,
(3)
industry: February Markit manufacturing PMI was
slightly ahead of estimates while the February ISM manufacturing index was a
tad below; January construction spending was terrible as were January factory
orders,
(4)
macroeconomic: the latest Fed Beige Book report was
upbeat; fourth quarter nonfarm productivity fell but the prior quarter was
revised up considerably; the January trade deficit was in line.
The Market-Disciplined Investing
Technical
The
indices (DJIA 17856, S&P 2071) had a rough week and a particularly lousy
Friday. However, they remained well within
their uptrends across all timeframes: short term (167215-19492, 1949-2930),
intermediate term (16795-21946, 1768-2482 and long term (5369-18860, 797-2112). Both stayed above their 50 day moving
averages but closed below their mid-December highs. Most important, I am reinstating the former
upper boundary of its long term uptrend.
The S&P could just not break through this resistance level in any
meaningful way---for the second time. The Dow is still 1000 points away from the
upper boundary of its long term uptrend.
Volume was up on
Friday; breadth was negative. The VIX was up but not as much as I would have
thought on a 300 point down day in the Dow.
It managed to close above its 50 day moving average but remained within
its short term trading range and intermediate term downtrend. I continue to think that, at these prices, it
represents cheap insurance for the trader.
The long
Treasury gave up its support level, finishing below the lower boundary of its
short term trading range. If it remains
there through the close on Tuesday, the trend will reset from a trading range
to down. It ended below its 50 day
moving average, close to the lower boundary of its intermediate term uptrend
and well within its long term uptrend. At
the Market open on Monday, the ETF Portfolio will Sell its position in
BWX. However, the muni ETF’s performed
much better than other sectors of the bond market; so for the moment at least,
those positions are being retained.
GLD’s pin action
was just terrible on Friday. It finished
below the lower boundary of its short term uptrend for the second day; but more
importantly, its drop in price was of a magnitude that the break now meets the
criteria of the distance element of our time and distance discipline. Hence, (1) the short term trend will re-set
to a trading range, the lower boundary of which coincides the lower boundary of
its intermediate term trading range and (2) the remainder of our Portfolios
positions in GLD will be Sold at the Market open Monday.
Bottom line: while
Friday was not a pleasant day in stock land, very little technical damage was
done to the Averages. What we can say is
that (1) there has been a marked loss of upside momentum and (2) the upper
boundary of the S&P’s long term uptrend once again offered too much
resistance for a clean break; clearly, if that remains the case the upside for
stocks is limited. On the other hand,
until uptrends start getting broken, there is little risk to the downside. All that said, our Portfolios remain Sellers
if any of their holdings trade within their Sell Half Range or if they no
longer meet our investment criteria.
Guess who is
selling stock in all those corporate buybacks? (medium and a must read):
TLT and GLD both
broke support. Accordingly, GLD is being Sold and as is a portion of our long
bond position in the ETF Portfolio.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17856)
finished this week about 49.2% above Fair Value (11966) while the S&P (2071)
closed 39.2% 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 put another spike in the heart of US economic growth and as such continue
to paint a dismal investment picture. We
now have six consecutive weeks of subpar US dataflow. And it is apt to get worse as a result of the
west coast longshoremen’s strike and the disruptive January/February weather
pattern.
In addition, the economic news from overseas returned
to its prior negative trend which only adds more downward pressure on our own
activity. I have not yet revised our
forecast but clearly that moment is not that far away.
That said any
downgrade in economic activity will have very little impact our Valuation Model
since I use moving averages for many of our inputs. However, a decline in Street forecasts will
certainly impact their estimates of corporate profits and almost surely many of
their valuation models.
Why no one cares
about negative data and declining earnings (medium):
The QE crowd got
another boost this week as the Bank of India lowered its key rates for the
second time in two months and the ECB promised E60 billion a month is asset
purchases until its economic goals are met---which for all practical purposes
will be never.
Or course, none
of this QEInfinity propaganda has ever resulted in the promised results. Indeed, the evidence grows daily that the
reverse is occurring: slowing growth
both here and abroad, inflation rates that are barely above 0%, pricing and asset
allocation irregularities in the financial system and the gathering strength of
a global currency war. Sooner or later,
I believe that these forces will be a detriment to the current extraordinarily
high stock prices.
One final note
on monetary policy. Investors reacted
negatively to the nonfarm payrolls beat on Friday, suggesting that they are
worried that this means the Fed will start to raise interest rates quicker than
assumed before. On strictly economic
grounds, I would disagree with this assessment.
First, the Fed knows that the preponderance of economic datapoints of
late have turned negative; second, it knows that employment is a lagging
indicator; and third, I am convinced that the Fed is more worried about the
Market than it is about the economy. So I
don’t believe that necessarily assures a more rapid rise in rates. That said, I have never understood how the
Fed economic models work (2007/2008 is a perfect example). So if somehow the Fed does raise rates in the
midst of an economic slowdown, I believe that it would precipitate the worst
case scenario for the Market.
At this moment, the
Greek/EU/ECB/IMF standoff has been pushed out for at least four months. However, this problem has not been solve and
as such, still presents the potential for a European financial crisis that
could ultimately impact all markets.
The two biggest
geopolitical risks to the Market continue at a slow simmer. The military action in Ukraine seems to be
subsiding but economic saber rattling has taken its place---which can be just
as destructive to the financial markets as the potential spread of a shooting
war.
The Middle East
is slipping into chaos and no one seems to have an answer. Iran is now leading the Iraqi attack on
Tikrit while congress and the president are trading blows over a nuclear arms
treaty with Iran. In addition, radical Islam seems to want to bring the
fighting to us. And even more
unfortunate than that, our government’s strategy is to treat these guys like a
bunch of street punks, instead of a well-armed, highly motivated fanatics that
want to wreak havoc with our country.
The risk here is that it takes another 9/11 or worse for those in charge
to comprehend the error of their way.
Bottom line: the
assumptions in our Economic Model haven’t changed though the yellow light is
flashing ever brighter as (1) the string of disappointing US stats moves
through its sixth week, (2) the central bankers continue to ramp up the very
policies that have inflicted damage on the global economy, and finally, (3) the
international dataflow turned negative again last week..
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.
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 3/31/15 12003 1491
Close this week 17856
2071
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.
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