The Closing Bell
4/18/15
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 16990-19767
Intermediate Term Uptrend 17104-22230
Long Term Uptrend 5369-18973
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1989-2970
Intermediate
Term Uptrend 1796-2567
Long Term Uptrend 797-2129
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
economic data this week was mostly negative: positives---March builders’
confidence, April Philly Fed manufacturing index, March PPI and April consumer
sentiment; negatives---March housing starts and building permits, weekly
mortgage and purchase applications, March industrial production and capacity utilization,
March leading economic indicators, March small business optimism, April NY Fed
manufacturing index, the March budget deficit and March CPI ex food and energy;
neutral---March retail sales and sales ex food and energy combo, March CPI and
the Fed Beige Book.
Housing starts,
industrial production, leading economic indicators and retail sales were the
big numbers this week---the score: negatives 3 and neutral 1. So both on both a quantity and quality basis,
the trend following last week’s nonevent is back to solidly negative.
An optimist on
industrial production (short):
The
international economic data was also downbeat.
While we did get another positive datapoint from the EU (auto sales),
China reported several, not just negative, but very negative stats. On the former point, this is the fifth week
of good numbers from the EU; though it is still too soon to state with
confidence that the EU is coming out of its slump. As I noted last week, one of the things that
holds me back is the unresolved problems of Greece and Ukraine. Both of which experienced adverse
developments this week and either of which could stop any potential recovery in
its tracks.
Our forecast:
‘a much 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.’
Unfortunately
for the ‘unmitigated positive’ crowd, oil prices appeared to have broken out of
their recent trading range to the upside. My question now is, will that same
group of folks start yakking about how negative this development will be were
it to continue?
Of course, the problem
that I am really worried 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 latest
numbers on rig count (short):
The
negatives:
(1) a
vulnerable global banking system. This
week, there was more fallout from the bankrupt Austrian bank as it claimed
another victim.
Another
potential problem that I have mentioned before is the consequences to the EU
financial system of a Greek exit---which seems to be gathering some
momentum. I am not predicting that it
will happen; gosh only knows that the EU ruling class has turned pulling back
from the brink of disaster a major art form.
Still it is a risk about which I believe that the pundits are bit too
smug.
Even the
banksters’ bankers are having problems (short):
‘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. The only news this week was the now growing federal deficit---which has
been part of major long term negative---too much spending, too high taxes, too
much regulation
In the interest
of being fair and balanced, several GOP presidential candidates offered plans
this week to address the spending/tax problems: tax reform [Rubio] and
entitlements reform [Christie]. We might
take some hope from this; but it is a long way until the elections and an even
longer way from the actual execution of any reform.
Rubio’s plan
(medium):
Christie’s plan
(medium):
(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.
Moody puts
student loan bonds on watch for downgrade (medium):
This week,
[a] ECB kept
interest rates unchanged {ZZZZZZZZZZ}.
While that maybe a snoozer, its bond buying program {QE} is causing all
kinds of problems, to wit, negative interest rates and an acute the scarcity of
government bonds---which has the ECB now looking at buying corporate debt; and
nothing says mispricing of assets like buying non-risk free bonds when you are
supposed to be buying risk free bonds,
[b] a Japanese government official suggested
that the current exchange rate for the yen was too high, i.e. it needs to
be devalued more,
[c] our own Fed
gave us a snoot full of dovish comments on Thursday after it dawned on them that
the US economy wasn’t doing too well.
At the risk of
being repetitious, I have suggested that the Fed would once again mishandle the
transition to normal monetary policy.
The evidence gathers daily that this economy has seen its highs in
growth; and after twelve weeks of nonstop bombardment, the Fed is getting a
clue that whatever transition it might have thought it could execute, whenever
it thought that the economy might be strong enough for higher rates, has all
been a giant wet dream. In short, the
Fed is still batting 0.000.
The important
point here is that if I am correct on the direction of the economy, the world
is going to have to alter its current ‘goldilocks’ scenario; and whatever the
new improved version is, it may not be quite as palatable as the one they dream
about at the moment.
(4) geopolitical
risks: tensions in the Middle East remain.
Iraq regained the spotlight this week as ISIS and Iraqi army units are
in a pitched battle. Unfortunately, ISIS appears to be winning. Equally regrettable, US friendlies appear to
be losing everywhere in the Middle East while the administration pursues a self-destructive
‘legacy’ policy with Iran which will in effect make it the hegemon of the
area---which got a boost this week when Putin agreed to sell it a state of the
art missile defense system.
James Baker on
the Iran deal (medium):
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.
Meanwhile,
violence in Ukraine is on the rise as Putin turns up the heat while Ukraine
tries to get funding from the IMF.
And the US now
officially has boots on the ground in Ukraine (medium):
(5) economic difficulties, overly indebted
sovereigns and overleveraged banks in Europe and around the globe. We got a single upbeat datapoint out of the EU
this week, keeping alive the prospect that the European economy may be starting
to turn.
However, the
rest of the news was pretty bleak: [a] China reported multiple negative stats,
[b] the Japanese reinforced their commitment to QE, [c] the latest WTO 2015 and
2016 world trade estimates were downgraded, [d] while the problems in Ukraine
and Greece just got worse.
With respect to
Greece, it continues to inch toward an exit from the EU. Perhaps not deliberately; more likely it is either
naiveté or recklessness. Specifically, the Greek government [a] once
again failed to deliver enough details on troika mandated reform measures to
earn it the financial assistance it so desperately needs [b] began discussions
with a well-known sovereign debt restructuring/bankruptcy attorney and [c] last
but certainly not least, began discussion with Paul Krugman---the same genius
that has been advising the Japanese government.
What could possibly go wrong?
In the
meantime, those optimistic pundits pronouncing that Greece offers no risk to
the EU or its financial system are getting a lesson in humility. Adding insult to injury, S&P lowered
Greece’s credit rating to CCC+.
More (medium):
And the latest
on the subject from the ECB (medium):
‘Muddling
through’ remains the assumption in our Economic Model. Hopefully, the recent EU data will continue
to improve; which should improve the odds of this scenario. On the other hand, [a] a Grexit remains a
decent probability and no one knows the unintended consequences of such an
event and [b] 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 resumed its downward
path.
Overseas, the EU
economy is still showing improvement, though we got some very rough data out of
China.
Meanwhile, QE
remains the principal theme among the central bankers as (1) the Japanese
central bank reiterated its devotion to currency devaluation, and (2) the Fed
officials offered up more crawfishing comments on rate hikes.
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.
Hoisington’s
first quarter review (a bit long but worth the read):
The geopolitical
hotspots remain unresolved (1) the Greeks and the Troika appeared to make no
progress this week, as the Greeks continued to look for ways to weasel out of
repaying their debts, (2) the Ukraine/NATO/Russia standoff heated up 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: March housing starts and building permits were
well below consensus; weekly mortgage and purchase applications were down; the
March NAHB builders’ index was better than estimates,
(2)
consumer: March
retail sales rose less than expected though ex food and gas they were slightly
better than anticipated; month to date retail chain store sales slowed markedly;
March consumer credit declined; weekly jobless claims were well ahead of
forecasts; April consumer sentiment rose fractionally,
(3)
industry: March industrial production fell twice the consensus,
while capacity utilization dropped; the March small business optimism index was
well below estimates; the April NY Fed manufacturing index was negative while
the Philadelphia Fed index was up from February,
(4)
macroeconomic: the March US budget deficit was larger
than anticipated; March PPI was up but less than in February; March CPI came in
on target, though ex food and energy, it was a hotter than expected; March
leading economic indicators were short of forecast and the February reading was
revised down; the latest Fed Beige Book was useless, except to blame any
shortfall on the weather.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17826, S&P 2081) finished the week on a major down note. The S&P has now made a second lower high
and kept that very short term downtrend intact.
As you know, on Thursday the Dow negated the existing upper boundary of
its very short term downtrend; however, it still didn’t get even with or above
the prior high, meaning that it too has marked a second lower high.
On the other hand,
the Dow closed right on its 100 day moving average, while the S&P remains slightly
above its comparable trend. Remember that
the 100 day moving average has proven a very resilient support level for the
past two years. So the next couple of
days pin action around this boundary could give us a hint on future short term
price movement.
Longer term, the
indices remained well within their uptrends across all timeframes: short term
(16990-19767, 1989-2970), intermediate term (17104-22230, 1796-2567 and long
term (5369-18873, 797-2129).
Volume rose; but
it was options expiration, so that was to be expected. Breadth was terrible. The VIX bounced 10%, finishing back above the
lower boundary of a pennant formation---which was negated by Thursday’s pin
action. I am reversing/putting on hold
that call until we see how the Markets trade next week. Meanwhile, it remained within its short term
trading range, its intermediate term downtrend, its long term trading range and
below its 100 day moving average. I
continue to think that the VIX remains a reasonably priced hedge.
The long
Treasury was up strong on Friday; not surprising given the equity market performance. It finished within its very short term and short
term trading ranges, its intermediate and long term uptrends and above its 100
day moving average.
GLD’s price rose,
closing within its short and intermediate term trading ranges, its long term
downtrend and below its 100 day moving average.
In addition to the really crappy overall performance of GLD, it is
starting to develop a head and shoulders pattern which, if completed, has
negative implications.
Bottom line: Friday’s
pin action (1) created a second lower high for both of the indices, (2) but
left them right on their 100 day moving averages which has offered considerable
strength recently. So short term, the
technical picture is a bit cloudy. How
the Averages handle their 100 day moving averages next week should provide some
insights on direction.
That said, 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 (17826)
finished this week about 48.1% above Fair Value (12036) while the S&P (2081)
closed 39.2% 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 poor
US and Chinese economic news only confirms the assumptions in our Valuation
Model.
The Japanese
enthusiastic embrace of QE notwithstanding, problems with this ineffective,
overused tactic continue to appear (1) in the EU, zero interest rates and the
scarcity of available bonds for purchase under their version of QE are severely
impacting the pricing of risk and the misallocation of assets, (2) in China,
rampant speculation in the securities markets have forced it to institute
measures [raising margin requirements] to reduce it, (3) while in the US, the Fed appears to have
overstayed its commitment to money forever and is now stuck with a decline in
economic activity and no policy levers to combat it save the same ones that
helped cause the problem in the first place. All these signs of the problems (misallocation
of investment, asset mispricing, encouraging speculation, beggar thy neighbor
currency devaluations, negligible economic improvement) of a failed QE; and all
signs that the correction process in the securities markets may be more painful
when it occurs.
Geopolitical
risks have not declined. The Greek bailout talks have progressed very little,
the outcome of the current Ukraine/NATO/Russia standoff is heating up again and
the military developments (ISIS progress in Yemen and Iraq; sale of a Russian
missile defense system to Iran) in the Middle East are increasing the explosive
potential there.
‘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.’
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.
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 4/30/15 12036 1495
Close this week 17828
2081
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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