The Closing Bell
4/4/15
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 16902-19679
Intermediate Term Uptrend 16989-22138
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 1974-2955
Intermediate
Term Uptrend 1787-2549
Long Term Uptrend 797-2122
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. Even
though there were a number of upbeat primary indicators this week, in sum, the
economic data was still negative: positives---February personal income, weekly
jobless claims, month to date retail chain store sales, February pending home
sales, weekly mortgage and purchase applications, March consumer confidence,
March light vehicle sales, February factory orders and March PMI manufacturing
index; negatives---February personal spending, the March Chicago PMI, the March
ISM manufacturing index, February construction spending, the March Dallas Fed
manufacturing index, the March ADP private payroll report, March nonfarm
payrolls, the January Case Shiller home price index and the February US trade
balance; neutral---March PCE price deflator.
The important positive
primary indicators were personal income, March light vehicle sales, February
factory orders and the March PMI manufacturing index; the negative, personal
spending, the March ISM manufacturing index, the February US trade balance, March
nonfarm payrolls and February construction spending. Plus, the Atlanta Fed reduced
its first quarter GDP estimate again (0.0%).
A brief word
about the February trade balance. Many
would argue that a declining trade deficit is a positive; after all, it would
suggest that the US is exporting more goods than it is importing---implying
that our factories are humming and all the world wants our ‘stuff’. In this case, however, both exports and
imports declined, imports are just declining faster. Exports are down due to the strong dollar;
imports are down because consumer spending is dropping off a cliff---neither is
a plus for the economy. Incidentally,
when exports and imports are both falling, that historically has been a
coincident indicator with recession.
I
would also note that even though February factory orders beat expectations
(+0.2% versus consensus of 0.0%), the January number was revised down from
-0.2% to -0.7%---meaning that for the two months combined, factory orders were
down 0.3%.
Finally,
the death star in these stats was the nonfarm payrolls number because that is
the datapoint to which that the Fed pays the most attention. (Incidentally, the January payrolls number
was revised down substantially). First, I repeat the refrain that one week does
not make a trend; so we need more data before getting too beared up. That said, my second point is that that
employment is a lagging indicator---meaning if it is rolling over, the rest of
the economy is well on its way to recession.
Third, while declining employment growth would be a negative for the
economy, it still might be a positive for the Market, as investor revel is the
prospects of an easy Fed. Fourth, it
would be a very clear indication that the Fed has kept its record on monetary
transition perfect (100% wrong). So if
the economy is slowing or moving into recession, it now the Hobbesian choice of
unwinding QE as the economy sinks or pumping even more destructive QE (capital
misallocation, asset mispricing) into the economy.
The upbeat
primary indicator notwithstanding, this is now the tenth week that the aggregate
numbers have been negative.
There were few
international stats and they were mostly negative. However, Europe again provided a bright spot
via its March manufacturing PMI. This is
the third week in a row for upbeat data from the EU. Not a trend yet but certainly a hopeful
sign.
If this
improvement is confirmed, my best guess as to what is happening is that it is
an initial reaction to the EU QE. However,
that doesn’t mean I will suddenly change my mind about the destructive impact
of QE. To draw a distinction between what may be occurring in Europe and the
rest of the world, remember that prior to its QE, the ECB had been following a
tight money policy. Conventional
economic theory holds that a reversal from tight to easy money will lead to an
improvement in the economic activity.
And that seems to be what is happening.
On the other
hand, Japan and the US have been pursuing easy money for so long, QE not only
lost its impact (Don’t forget, I have always said that QEI had beneficial
effects.) but has become a negative force in the economy. The point here being that like the US, sooner
or later QE will be just as negative a force in Europe as it has become in the
US. So the question is, how long will
the ECB new QE have a plus effect on the EU economies, assuming that it was the
trigger for better numbers and that the numbers remain upbeat? Equally important, if the trend continues (1)
will the improvement be strong enough to sustain itself when the economies of
its major trading partners (the US, China and Japan) are losing steam (which
this week’s stats continued to support)? and (2) can it weather adverse
developments in Greece and Ukraine?
Speaking of the Greek
bailout, the government submitted is revised, revised, revised plan that is
supposed to meet the troika’s guidelines for approving bailout funds. Not surprisingly, it again failed to
incorporate sufficient specificity to gain troika approval. Oh well, back to the drawing board. Meanwhile the clock is ticking on the due
date for certain loan repayments which the bail out money was to fund. I have seen no revisions from the experts on
their 50/50 odds of a Grexit.
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.
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.
Latest tally on
rig count (short):
On a related
item, banks are now cutting their lines of credit to the oil companies (medium
and a must read):
The
negatives:
(1) a
vulnerable global banking system. This
week:
[a] Chase
reported that it was near providing $13 billion in customer relief over its
mortgage program and HSBC reached a $1.9 billion settlement related to its
money laundering activity,
[b] you would
think that these clowns would have learned their lesson. But noooo, it appears that they are driving
to the hoop on subprime auto loans.
[c] plus the
tale of that bankrupt Austrian bank continued to worsen and is starting to
reveal the extent of exposure to derivatives on EU bank balance sheets.
‘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. Gone fishing. No news.
(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.
The illusion of
prosperity created by QE (medium and a must read):
China got the
QE drive to destruction back on track this week, as a senior banking official
told markets that the Bank of China was prepared for more money printing and that
it also took steps to revive the flagging real estate market.
(4) geopolitical
risks: the violence continues in the Middle East as the Saudis and Egyptians
are committed to defeat of the Houthis rebels in Yemen [although to date they
are doing a pretty lousy job of it] and the action in Iraq is getting confusing
as the Iranian troops fighting around Tikrit accused the US of bombing them
versus the ISIS rebels. The risk of some
form of civil war between Sunnis and Shi’as mounts. A civil war would most likely not be good for
regional oil assets.
On another
front, yesterday Obama announced a format for an outline of a deal with Iran on
its nuclear program. I am not sure what
a format for an outline of a deal means other than face time for the president
and secretary of state. However, to be
fair on the surface the terms outlined sounded reasonable. But as always, the devil is in the details. The question is will anything come of
it? The skeptic in me says no way
Melvin. The optimist in me says at least
we didn’t sign a bullshit deal. Here is
a copy of the format for an outline:
Friday morning
humor (short):
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. Global stats appear to be diverging. Europe is now in its third week of improving
economic stats. That is not enough data
to warrant a change in forecast; however, it is a good sign that Europe may
have turned the corner. That would make
some sense in that until the recent QE policy was initiated, the ECB had been
following a tight money policy. So some
reflex action would be within historical experience. On the other hand, there has been no help on
the fiscal policy side which again historically usually accompanies money
policy changes.
Further, even
assuming the EU economy is now coming off a bottom (1) can that improvement be
sustained when China, Japan and the US continue to deteriorate and (2) what
occurs if the Greek bailout and/or the Ukraine/NATO/Russia standoff lead to
disruptions. In short, the recent dataflow
is clearly a positive but for it to be meaningful, there must be some follow
through and Greece and Ukraine have to somehow ‘muddle through’.
Latest on
Greece---Tsipras heads to Moscow (medium):
While back at
home, Greeks are anticipating a Grexit (medium):
‘Muddling
through’ remains the assumption in our Economic Model. Hopefully, the recent EU data will continue; which
should improve the odds of this scenario.
On the other hand, the Chinese and Japanese economies continue to falter
and they collectively are bigger than the combined EU economies. This remains
the biggest risk to forecast.
Bottom line: the US economic news was negative for the
tenth straight week. Estimates continue
to be lowered for economic and profit growth, though no one has yet uttered the
‘r’ word.
Overseas, the EU
economy may be in the process of turning the corner though it is too soon to
know. Elsewhere the lousy numbers just
keep on coming. The questions being, is
the EU anticipating a global rebound; but if it is not, can it sustain the
recent improvement when its major trading partners continue to
deteriorate. China revved up the QE,
currency devaluation race this week which will not help any EU recovery or
overall growth prospects worldwide.
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.
The geopolitical
hotspots remain unresolved (1) the Greeks and the Troika seem to get a mille
short hair closer to a bailout plan; but not enough to raise optimism, (2) the Ukraine/NATO/Russia
standoff continues and (3) the Middle East violence has escalated raising the
odds of a Sunni/Shi’a civil war---which almost certainly won’t leave oil
supplies unscathed.
This week’s
data:
(1)
housing: February pending home sales was above estimates;
weekly mortgage and purchase applications were up; the January Case Shiller
home price index rose more than anticipated,
(2)
consumer: February
personal income was better than consensus, personal spending worse and the PCE
deflator in line; the March ADP private payroll report was well short of
forecasts as was March nonfarm payrolls; weekly jobless claims declined versus
estimates of a rise; month to date retail chain store sales were up slightly; March
light vehicle sales improved; March consumer confidence was above expectations,
(3)
industry: the March Chicago PMI was disappointing; the
March PMI manufacturing index was slightly better than estimates; the March ISM
manufacturing index was much less than anticipated; February construction
spending declined versus consensus of an increase; February factory orders were
better than forecast, the March Dallas Fed manufacturing index was well below estimates,
(4)
macroeconomic: the US February trade deficit was less
than anticipated.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17763, S&P 2066) recovered yesterday. But both remained below the lower boundaries
of their very short term uptrends. Under
our time and distance discipline, that would warrant negating those
uptrends. However, because both of the
Averages (1) ended very close to those trend lines and (2) finished either
right on [Dow] or above [S&P] their 100 day moving averages, I am holding
off. On the latter point, it appears
that 100 day moving average has again provided meaningful support.
Longer term, the
indices remained well within their uptrends across all timeframes: short term
(16902-19679, 1974-2955), intermediate term (16989-22138, 1785-2547 and long
term (5369-18860, 797-2122).
Volume declined;
breadth improved. The VIX was down,
finishing 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 it remains a reasonably priced hedge.
Update on
sentiment (short):
The long
Treasury was hit on Friday though it had a good week. It ended within its short term trading range,
intermediate and long term uptrends and above its 50 day moving average. Unfortunately, in Friday’s pin action, TLT
could not get above its last high which could suggest declining momentum. How much follow through there is to the
downside will give us hint directionally.
Counterpoint
(short):
GLD’s price fell,
but closed within its short and intermediate term trading ranges, its long term
downtrend and below its 50 day moving average.
GLD still has a number of tough resistance levels yet to overcome before
we can assume that the worst is over.
Bottom line: short
term I am watching the pin action around the lower boundaries of the indices
very short term uptrends and their 100 day moving averages for hints of direction. Longer term, the trends are solidly up and
will be so until the short term uptrends, at the very least, are negated.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (17763)
finished this week about 47.5% above Fair Value (12036) while the S&P (2061)
closed 37.8% overvalued (1495). 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
stats were negative, but in fairness did contain some positive primary
indicators. In addition, the Atlanta Fed
lowered its first quarter GDP forecast again (now +0.0%) and company forward
earnings guidance is dropping. Nothing
here to warrant altering our Economic Model or change the assumptions in our Valuation
Model.
The global
economic news seems to be diverging with Europe showing signs of recovery while
the rest of the world slows down. As I
noted above, it is too soon to know if the EU economy is mending; and even if
it is, I am not sure it can sustain that improvement if the growth rates in
China, Japan and the US economies are declining.
In addition, the
Greek bailout talks have progressed very little, the outcome of the current
Ukraine/NATO/Russia standoff is uncertain and, the just announced format for an
outline of an Iranian nuclear deal notwithstanding there remains a considerable
distance between the cup and the lip.
As I noted last
week, 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.
Global QE got
another boost this week from China.
There really isn’t much to say to this development except that it only
makes the problems QE has already created worse (misallocation of investment,
asset mispricing, encouraging speculation, beggar thy neighbor currency
devaluations). Regrettably, it will also
likely make the correction process more painful; and nothing says correction
like the spread between current prices and Fair Value as calculated by our
Valuation Model.
Bottom line: the
assumptions in our Economic Model have recently 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 4/30/15 12036 1495
Close this week 17763
2066
Over Valuation vs. 4/30 Close
5% overvalued 12637 1569
10%
overvalued 13239 1644
15%
overvalued 13841 1719
20%
overvalued 14443 1794
25%
overvalued 15045 1868
30%
overvalued 15647 1943
35%
overvalued 16248 2018
40%
overvalued 16850 2093
45%overvalued 17452 2167
50%overvalued 18054 2242
55%
overvalued 18655 2317
Under Valuation vs. 4/30 Close
5%
undervalued 11434 1420
10%undervalued 10832 1345
15%undervalued 10230 1270
* 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.
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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