The Closing Bell
3/21/15
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 (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 16814-19585
Intermediate Term Uptrend 16859-22044
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 1962-2943
Intermediate
Term Uptrend 1779-2533
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 neutral 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, February building
permits; negatives---the NAHB sentiment index, February housing starts, weekly
mortgage and purchase applications, the March NY and Philly Fed manufacturing
indices, February industrial production and capacity utilizations, February
leading economic indicators and the fourth quarter trade deficit;
neutral---none.
While it was a
slow week for data points, there were three important numbers: housing
starts/building permits, industrial production and the leading economic indicators---all
negative, although building permits were something of an offset to housing
starts.
There was almost
a dearth of international stats though here too the trend remains negative. In addition, the Greek bailout is in total disarray. True, the Greeks promised action on a fiscal
plan yesterday. But they have done that
before and (1) their subsequent ‘plans’ missed the Troika’s guidelines by a
mile, (2) while their rhetoric was defiant and inflammatory. It may be different this time; but the onus of
proof is on the optimists. Of course,
the optimists also believe that if a Grexit occurs it will have little impact
on the EU economy. That may be
true. But events have unintended
consequences; and I would like to know those before dismissing this as a minor nuisance.
In short,
nothing in the numbers to suggest that the US and global economies aren’t
slipping backwards. Unfortunately, this
has been going on long enough that it warrants a change in our forecast. Accordingly, I am revising 2015 outlook for
(1) economic growth from 2-3% to 0-2%, (2) inflation from 1.5-2.5% to 1.0-2.0%
and (3) corporate profit growth from 5-10% to -0.5-+0.5%. Note that this is not a recession forecast;
but it does incorporate the probability of a decline in earnings. I assume you noticed the change in verbiage
in the first paragraph.
Corporate cash
and profitability may not be as good as you think (medium and a must read):
http://www.zerohedge.com/news/2015-03-20/record-corporate-cash-and-profitability-are-lies-here-truth
As you know, the
FOMC met this week and pulled the biggest sleight of hand I can recall. It removed the word ‘patient’ from its
statement, implying that it would tighten soon, but then sounded more dovish than
ever in the remainder of the text. I
think that this is in recognition of my theme for the last eight weeks, to wit,
the economy is slowing down. On the
margin, this is a plus in my opinion, in that, a rise in rates would only
increase the odds and/or magnitude of any slippage in economic growth. That said, it also recognizes that the Fed
once again has bungled the transition from easy to tight money. It is now in the position of facing a
declining rate of economic growth with no policy tools left in its bag save
more of the same (QE) that got us into the current mess we are in in the first
place.
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.
There is also a
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.
The
negatives:
(1) a
vulnerable global banking system. This
week that Austrian bank mentioned in the last Closing Bell went into default
and claimed a German bank as its first victim.
In addition, proving once again that our ruling class is either too
stupid or too preoccupied with self-serving endeavors to learn a lesson, it now
appears that there is a decent probability that Fannie and Freddie will require
another round of bail out money.
On the criminal
enterprise front, BNY Mellon agreed to pay a $714 million fine for foreign exchange
fraud.
‘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. This week, a tax reform measure
is being worked on in the House. At first blush, it has a number of positive
proposals [lower tax rates accompanied by fewer deductions]. However, before getting too jiggy, it needs
to at least get to a vote in the House.
Let’s hope.
(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,
Sweden lowered interest rates while the Bank of Japan reiterated their devotion
to same. In our own backyard, the Fed
basically admitted that QE hasn’t worked but that it doesn’t know how to get
out of the mess it is in. So the
solution is to do nothing. Regrettably,
nothing is something; and that something is weakening the dollar [higher interest
rates strengthens a currency] which I fear contributes to the global race to
see who can post the lowest interest rate and will only spawn more of the same
results, i.e. declining economic activity and deflation.
This is a great
essay on the negative impact of QE (medium and today’s must read):
Does the Fed
mandate of price stability = 2% inflation (medium and another must read):
(4) geopolitical
risks. The saber rattling continues in
Ukraine but has now managed to spread across the NATO/Russian border. Implied threats are rising and coming with
more frequency, the most belligerent of which was this week’s statement by
Putin that he would have used nukes to defend Russian’s annexation of Crimea. I don’t really believe that this standoff will
turn into a shooting war though the economic sanctions part of this faceoff
could have an impact on an already slowing global economy.
The Middle East
is nothing but murderous chaos; and the administration is attempting to cut a
deal with Iran on its nuclear program.
As I am sure you are aware, many in the government are worried that
Obama and His minions don’t have the chops to negotiate an agreement that will
effectively halt the Iranian drive to hoop.
In addition, Netanyahu was re-elected and if he doesn’t like the deal
that introduces another wild card into the picture. I have no idea how this could play out; but
clearly there are some potential negative outcomes.
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. While we
received some positive economic stats from the rest of the world, the dataflow
in totality is negative, in particular, the report that Chinese GDP grew at the
lowest rate in 20 years.
In addition, the
Greeks have not been particularly cooperative in terms of meeting the fiscal
demands of the Troika. That has served
to move both parties closer to a Grexit.
However, as I noted above, Greece announced on Friday that it would
provide a plan that meets the requirements.
That said, the Greeks and the Troika have been at this exact place
before in what appears to be a game of ‘chicken’---to which someone is going to
have to blink and it has to be soon because Greece is running out of
money. Who knows where either parties ‘uncle’
point is. But I think it safe to say that
there is some probability of a Greek exit from the EU; and while numerous
pundits have pronounced it of little import, I am always worried about
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.
Finally, there
is the economic battle going on between NATO and Russia. I am no foreign policy expert; so I am not
predicting any outcome. But I am
concerned about what happens to EU economic growth if Russia turns off the gas
spigot.
In short, ‘muddling
through’ may continue but I believe that time is running out, particularly on
the economic policies of the EU. This
remains the biggest risk to our downwardly revised forecast.
Bottom line: the US economic news was lousy for an eighth
straight week. Even the Fed has awakened to that fact. I think it time to scale back our outlook for
economic and corporate profit growth as well as inflation. Those new numbers
are above.
The easy money crowd
continues to get more good news this week as Sweden lowered its key rates while
the Fed and Bank of Japan renewed their vows to QE. 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.
Overseas, (1)
the stats don’t seem to be improving, (2) Greece is on the verge of default and
(3) the shouting war between NATO and Russia goes on unabated. The faltering economic data are the easiest
to deal with, in that there are historic relationships between economic growth
of our trading partners and ourselves that can at least give a hint of
potential problems---and that hint is recession if the trend continues unabated. The EU/Greek standoff is like trying to
predict the outcome of the gun fight at the OK corral; and the NATO/Russia cat
fight is even more difficult. The best
case is that they all ‘muddle through’; the worst case is that EU QE doesn’t
work any better than it has for others, so Europe continues to slide into
recession, Greece defaults and Russia turns off the gas.
This week’s
data:
(1)
housing: the NAHB sentiment index was below estimates;
February housing starts were atrocious; weekly mortgage and purchase applications
fell,
(2)
consumer: month
to date retail chain store sales picked up slightly; weekly jobless claims were
very slightly better than forecast,
(3)
industry: the March NY and Philadelphia Fed
manufacturing indices were below expectations; February industrial production
and capacity utilization were less than anticipated,
(4)
macroeconomic: February leading economic indicators
came in below estimates; the US fourth quarter trade deficit was larger than consensus.
The Market-Disciplined Investing
Technical
The
indices (DJIA 18127, S&P 2108) ended the week with a bang on a quad
witching Friday, though they continue their up day/down day pattern. They remained well within their uptrends across
all timeframes: short term (16814-19585, 1962-2943), intermediate term (16859-22044,
1779-2533 and long term (5369-18860, 797-2116).
Both stayed above their 50 day moving averages. Friday’s moonshot puts them within striking
range of the upper boundaries of their long term uptrends; so I assume that
they will mount another challenge.
However, I continue to believe that they will be unable to break the
gravitational pull of those boundaries.
Volume was up on
Friday---it was a quadruple witching day, so no surprise. Breadth was positive; also not unusual. 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, finishing within its short term trading range, intermediate and
long term uptrends and above its 50 day moving average. Every day we get this kind of positive pin
action, it appears more and more like its chart has stabilized.
GLD’s price
picked up on Friday. However, it still
closed within its short and intermediate term trading ranges, its long term
downtrend, below its 50 day moving average and within a very short term downtrend. This is not a pretty chart.
Bottom line: a
good Friday capped off a good week for stocks.
While they have been in a fairly consistent pattern of one day up then
one day down, the price moves on the up days this week were greater than those
on the down days. I guess that means
that momentum has returned to the upside though (1) the huge Friday move was
driven at least partially by options expiration which could easily reverse itself
on Monday and (2) the up day/down day pattern doesn’t exactly inspire great
confidence in a sustained directional move.
Nonetheless, given the Averages’ proximity to the upper boundaries of
their long term uptrends, I would expect a challenge of those levels although I
don’t believed that they will be sustained.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (18127)
finished this week about 51.4% above Fair Value (11966) while the S&P (2108)
closed 41.7% 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 abysmal---again. Plus the
global economy continues to slowdown. The
good news is that the Fed seems to recognize all this; hence, the dovish tone
coming from this week’s FOMC statement. The
bad news is that (1) the Fed once again has stayed too loose for too long and
now it has no policy arrows to combat a decline in activity and (2) its move
reinforces the continuing trend of other major central banks towards
competitive devaluations. Neither have any
socially redeeming features and both will likely only exacerbate the current slowdown. In sum, they point to a necessary change in
our outlook---slower economic growth, lower corporate profit growth, if any at
all and lower inflation.
How accurate is
Fed forecasting? Not very (medium):
Richard Fisher
on stock valuation (medium):
However, as I have
pointed out previously, this will have little to no impact on our Valuation
Model since it uses long term moving averages for these inputs. Of course, since our Model already has Fair
Value for the Averages as well as many of the stocks in our Portfolios at
considerably lower levels, it will not likely prompt any actions. Indeed, so many of our stocks have already
traded into their Sell Half Ranges, much of my work on the sell side has
already been done. Admittedly, sooner
than I might otherwise have wanted. But
that is yesterday’s story.
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.
To be sure,
there are risk scenarios out there than could impact our Models: a global
recession of some magnitude brought on by the current competitive devaluation
race, a default in the financial system brought on by too much leverage
(derivatives) or an unanticipated consequence of a Greek bankruptcy (even
though the Market got very jiggy with Friday’s statement from Greece that it
would submit a plan pronto), a major flare up in the Middle East that severely
impacts energy supplies/prices, a misstep in the NATO/US/Russia face off or
another 9/11 like tragedy.
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, the 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.
Are
we in a bull or bear market (short):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 3/31/15 12003 1491
Close this week 18127
2108
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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