The Closing Bell
5/16/15
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 17174-19971
Intermediate Term Uptrend 17322-22439
Long Term Uptrend 5369-19175
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2016-2995
Intermediate
Term Uptrend 1820-2591
Long Term Uptrend 797-2135
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 51%
High
Yield Portfolio 52%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy is a neutral for Your Money. It is
now 15 out of 16 weeks of poor economic data: positives---month to date retail sales,
weekly jobless claims, the April small business optimism index, March business
inventories/sales, the April US budget surplus; negatives---weekly mortgage and
purchase applications, the April retail sales, May consumer sentiment, April
industrial production, the NY Fed May manufacturing index, April export/import
prices, April PPI; neutral---none.
April retail
sales and industrial production were the key numbers this week---both negative.
In addition, the fall in April PPI and
export/import prices give further weight to the notion of a very weak (deflationary)
economy. So it looks like all the
pundits that blamed lousy February and March stats on weather and the west
coast longshoremen’s strike are probably going to have to re-boot their models.
On the other
hand, bond and gold prices are suggesting a pickup in economic activity/inflation. Clearly, these inconsistencies add confusion
to the mix. But in the end, my bias is
to opt for longevity, i.e. the economic data has been subpar for almost 16
weeks while the bond and gold markets indication of improvement is much shorter. Plus, bond and gold are one off signals of
economic activity versus the real deal; so there could be noneconomic explanations
for their behavior.
The
international economic data was mixed, with Europe continuing to show better
results. That is the only bright spot in
an otherwise dismal global economic outlook and is the major reason that I am
clinging to the ‘muddle through’ scenario by my fingernails. Unfortunately, the Greek bailout situation
seems to be nearing an end game where the possible outcomes include default or
a Grexit---either of which could throw a giant monkey wrench in any EU recovery.
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.’
Update on big four
economic indicators (medium):
The pluses:
(1)
our improving energy picture. Oil production in this country continues to
grow which is a significant geopolitical plus.
However, [a] lower oil prices failed to bring the consumer spending
bonus so many pundits expected and [b] prices now appear to have bottomed and
are moving up.
I noted last
week that ‘If energy prices have stabilized, absent any delayed consumer
response, then the lower prices part of this positive factor no longer applies.
On the other hand, my concern about fracking related junk debt on bank balance
sheets may also not apply.’
Unfortunately, I may have jumped the gun on the latter part of that
statement as there still appears to be more trouble coming (medium):
The
negatives:
(1)
a vulnerable global banking system. Multiple incidents this week. Some actually demonstrating that the
regulators as well as the TBTF institutions are working on reducing the magnitude
of this risk:
[a] Fed
regulators raised oversight of MetLife as a threat to the financial system,
[b] Morgan Stanley
sold its oil trading operation,
[c] the DOJ is
contemplating ripping up an agreement not to prosecute UBS for rigging interest
rates.
But that doesn’t mean that all problems have been solved:
[a] five banks {including JP Morgan and Citi} plead
guilty to foreign exchange fraud---but no one goes to jail,
[b] nor is anyone else accused of 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, congress failed to approve fast track authority for Obama in
negotiating the Trans Pacific partnership talks. I linked to an article that voiced objections
to this agreement some of which were reasonable. Later in the week, it looked like an amended version
would be submitted for a vote; so it seems that our political system is simply
in the process of refining this agreement in order to achieve a better end
result. I would add that just
negotiating an issue is a welcome reprise from the last six years of a
hamstrung, do nothing senate.
Greg Mankiw on
trade (3 minute video):
(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,
China cut interest rates for the third time and introduced its own version of QE
which looks quite similar to the EU variety.
Whatever its form, it is still QE and helps keep the party going.
And the Chinese
bail out has started (short):
On the other
hand, global bond markets continued to get hammered this week in spite of
plenty of weak economic news [suggesting more QE and lower inflation expectations]. The reasons for this phenomena seem to be
coming into focus. It appears to be a
combination of [a] the central banks have bought so much debt paper, that there
is not much left to buy, [b] hence, the fear that if the central banks ever
start to sell, prices will drop precipitously, [c] because government
regulation of bank trading desks {i.e. the market makers and hence the source
of liquidity} has become so onerous that they are getting out of the business. That and the fact that buying a zero to
negative coupon bond can only be a ‘greater fool’ trade, i.e. if you are
deriving no income from a trade, the only way to make money is selling it at a
higher price. That might work with growth
stocks, but a bond is no growth stock. In
short, the bond guys may be starting to question the rationale for QEInfinity.
When as and if
that occurs, as I have noted repeatedly, the economic impact will likely be
limited since QE has done nothing to spawn economic growth but the effect on
the stock market which has benefitted greatly from QE will probably be quite
negative.
(4) geopolitical
risks: this week Arab leaders shunned Obama’s Middle East summit, sending a
clear message [in my opinion] that His Iran appeasement policy sucks. That is not likely to sway the Ideologue in
Chief and it will probably only make matters more difficult in resolving the
problems in that area of the world.
Iran sends naval
escort for ship carrying ‘humanitarian’ aid to Yemen (short):
In addition, Kerry
went to Russia this week to try to make nicey nice with Putin in the hopes of
calming the confrontation in Europe and elsewhere. I applaud the effort. But given the administration’s inept execution
of foreign policy to date, I have no reason to assume that Putin won’t get out
the Vaseline and do whatever you do with Vaseline.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. It was another light week for
international data. Europe continued to
show economic improvement---the bright spot in an otherwise dismal global
outlook. Speaking of which, the numbers out
of China were pretty bad.
Slowing global
trade (medium):
However, the
Greek/Troika bailout discussions continued to hold center stage. There was one piece of faux positive news:
Greece made a E750 million IMF debt payment; but did so by drawing on its
reserves at the IMF which have to be repaid within 30 days. In short, Greece used E750 million of
precious cash in order to keep its liabilities flat.
Other than
that, the odds of a bail out continued to decline: [a] the IMF told the Troika
it was no longer interested in participating in the bailout talks and began
preparing for an exit, [b] internal pressure rose on Merkel to cut Greece loose,
[c] and surprise, surprise, it turns out that the EU does have a Plan B {read: Grexit}
for dealing with this situation.
Why the Greeks will blink (medium):
My bottom line here hasn’t changed: I don’t know how this ends, I don’t
know what that means for the markets but I do believe that there will be
unintended consequences; and since those are by definition unknowable, this
situation demands some caution.
‘Muddling
through’ remains the assumption for the global economy in our Economic Model
with the proviso that if a Greek default/exit occurs, all bets are off. This
remains the biggest risk to forecast.
Bottom line: the US economic news maintained its downward
path; though there continues to be improvement in the eurozone. That is the sole bright spot and, frankly, I need
it just to keep ‘muddling through’ as a plausible scenario.
Meanwhile, the somewhat
mystifying rise in interest rates continued. I think that I am getting a handle on the ‘why’
of what has been a confusing development.
Unfortunately, if (operative word) I am right, it will be of little help
to either the US/global economy or the US/global markets.
One geopolitical
hotspot maybe getting unresolved while the other remain just so (1) the Greeks
and the Troika made no progress this week, and it appears that the endgame is
rapidly approaching, (2) US/Russia face is hopefully [operative word] de-escalating
with Kerry’s visit to Russia this week and (3) the geopolitics of the Middle
East got more muddled as Arab leader shun Obama’s Middle East ‘summit’.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications declined,
(2)
consumer: month to date retail chain store sales improved,
while April retail sales were below expectations; weekly jobless claims rose
less than forecast; May consumer sentiment was well below consensus,
(3)
industry: April industrial production fell; the NY Fed
manufacturing index was less than anticipated; April small business optimism
index was better than estimates; March business inventories were up less than
consensus but sales were strong,
(4)
macroeconomic: the April US budget surplus was higher
than expected; April export and import prices dropped more than forecast; both
the headline and ex food and energy April PPI were terrible.
The Market-Disciplined Investing
Technical
The indices
(DJIA 18272, S&P 2122) finished the week on a high note after a volatile
week. Both closed above their 100 day
moving average, negated their trends of lower highs but ended out of sync with
respect to their former all-time highs.
The S&P above while the Dow hasn’t made it yet.
Longer term, the
indices remained well within their uptrends across all timeframes: short term
(17174-19971, 2016-2995), intermediate term (17322-22430, 1820-2591 and long
term (5369-19175, 797-2135).
Volume rose on
Friday; but it was option expiration day, so that is not surprising. Breadth was mixed. The VIX fell all week, finishing below its
100 day moving average and the upper boundary of a very short term downtrend---both
positives for stocks. However, it is
again nearing the lower boundaries of its short and long term trading
ranges. The closer it gets, the more
attractive it becomes as portfolio insurance.
Following big
declines early in the week, long Treasury moved modestly up on Friday. Still it
remained below its 100 day moving average and the upper boundary of a short
term downtrend.
For two weeks, I
have been harping on the divergence of the bond and stock markets, primarily
because they potentially imply totally different economic scenarios: the stock market
rising on weak economic numbers/easy Fed while the bond market is falling presumably
on better growth and higher inflation.
Confusing
matters even more (1) our internal indicator does not support higher stock
prices, (2) gold is supporting the higher inflation scenario and (3) a
progressively more vocal discussion has developed on whether or not QE has
reached in logical conclusion [i.e. the central banks will have a very
difficult time expanding their already huge positions in sovereign debt] and
the degree of liquidity available in the securities markets due to the exit of
large amounts of bank trading capital from the market making function.
I have no idea
how all these factors resolve themselves.
But till they do, I think patience is needed.
As I noted
above, GLD has been acting a bit better, ending the week slightly above the
neck line of the head and shoulders pattern.
If it remains above that level through the close on Tuesday, that
formation will be negated and the short term trend will re-set to up. However, given the head fakes GLD had thrown
at us in the last year as well as the fundamental uncertainty surrounding the
reason for its better performance, I am going to be very cautious before
re-entering this trade.
Finally, adding
just a bit more to the overall confusion in and among the markets, (1) oil was
flat this week, finishing right around the upper boundary of a short term
trading range---despite the Saudi’s giving themselves a high five for torching the
US fracking market and (2) the dollar broke a short term uptrend, supporting
the notion that the Fed could remain easier, longer than previously thought.
Bottom line: the
bulls are pressing, with the Averages finishing above the trend line of lower
highs---which was also the upper boundary of a narrowing very short term
trading range. The only fly in their
ointment right now is that the S&P has managed to close above its former all-time
high, while the Dow remains below its comparable level. Nevertheless, it
appears that the momentum has changed to the upside; so we start looking at the
upper boundaries of the indices long term uptrends as the next resistance
point. I am standing firm that these
will prove insurmountable on any time frame save the very short term.
That said, longer
term, the trends are solidly up and will be so until the short term uptrends,
at the very least, are negated.
The
long Treasury’s recent pin action continues to suggest either inflation or a
re-evaluation by investors of the sustainability and/or efficacy of QE. Both clearly run counter to the message to
the stock market. Plus the volatility in
gold, oil and the dollar only add their own version of a confused message. I have no clue what long rates are going to
do; but I worry that about the ‘why’ of what they will do.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (18272)
finished this week about 51.3% above Fair Value (12073) while the S&P (2122)
closed 41.5% overvalued (1499). 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 international economic stats confirm the economic assumptions in our
Valuation Model. It does appear that
recovery has taken hold in Europe which helps keep our outlook for the US economy
as growing slowly rather than recession.
However, even that scenario points to lower corporate profits. As I have explained numerous times that won’t
impact the numbers in our Valuation Model, but it will almost certainly force
changes in Street Models which will likely cause heartburn for equity prices.
Stock investors
continued to love QE and all manner of evidence suggesting that it will endure. Market reaction to this week’s crappy data
being a perfect example. However, the
bond guys did not react with the same enthusiasm which begs the question, have
they finally had enough of QE? I still
don’t have an answer for that. The
period of divergence has been short enough that it could be nothing but a
severe market reaction to the earlier plunge of EU rates into negative
territory.
On the other
hand, I am concerned about the growing number of voices pointing to the lack of
liquidity in the bond markets caused primarily by the central banks physical
inability to continuing to buy huge chunks of sovereign debt simply because supply
is now limited due to ginormous past purchases plus the downsizing of bank
trading desks which have traditionally been the market makers that brought a
semblance to order to price movement.
The bottom line is that this is a confusing issue that has big potential
implications for future price movements in the securities’ markets.
Geopolitical
risks potentially declined a tad, as it looks like the US has blinked over
Ukraine. That probably assures that the
status of the original alignment of Ukraine within the Russian sphere returns
after some very stupid maneuvers by the US to replace the government. Hopefully this removes the potential of a
US/Russian showdown in which I have no doubt that US would be humiliated.
However, there
was no progress in the Greek bailout talks as the Greeks have been getting ever
more strident in the negotiations (if that is what you want to call them) with
the Troika. The odds of default or
Grexit seem to have risen. While I can’t
predict that this will impact markets, there will be unintended consequences
which certainly could. Meanwhile, Arab
leaders snubbed Obama at His Middle East summit which suggests that the risks
of conflict (oil shortages) have grown.
‘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 are unchanged but still in danger of being
revised down again. If they are anywhere
near correct, they will almost assuredly result in changes in Street models that
will have to take 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.
The Dividend Growth Portfolio and High Yield Portfolio Sold their
positions in COP this week.
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 5/31/15 12073 1499
Close this week 18272
2122
Over Valuation vs. 5/31 Close
5% overvalued 12676 1573
10%
overvalued 13280 1648
15%
overvalued 13883 1723
20%
overvalued 14487 1798
25%
overvalued 15091 1873
30%
overvalued 15694 1948
35%
overvalued 16298 2023
40%
overvalued 16902 2098
45%overvalued 17505 2173
50%overvalued 18109 2248
55%
overvalued 18713 2323
Under Valuation vs. 5/31 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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