The Closing Bell
5/23/15
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 17220-20025
Intermediate Term Uptrend 17378-22506
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 2021-3000
Intermediate
Term Uptrend 1826-2593
Long Term Uptrend 797-2138
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. The
preponderance of data this week was negative though two primary indicators were
pluses: positives---April new home sales and building permits, April leading
economic indicators and April CPI ex food and energy; negatives---weekly
mortgage and purchase applications, May homebuilder confidence, April existing
home sales, month to date retail sales, weekly jobless claims, the April
Chicago national activity index, the May Markit flash manufacturing index and
the May Philly Fed and Kansas City manufacturing indices; neutral---none.
Clearly volume
wise this was a rough week. To be sure,
the new home sales and leading economic indicators were very important positives. But new home sales were more than offset by
the headline existing home sales (which are ten times the magnitude of new home
sales). Realtors are countering that the
disappointing number was a function of low supply versus low demand. Bear in mind that they are just talking their
book. In fact, in the same existing home
sales press release, inventories (i.e. supply) were listed as climbing in April. So I am counting the new versus existing home
sales as a wash. In short, we are at sixteen
out of seventeen weeks of lousy data and counting.
There was a bevy
of Fed related news all of which I covered in Morning Calls and discuss briefly
below. In sum though it was confusing in
part because Fed seems to be trying to weasel the economic data to look better
than it is. I continue to wonder if the
Fed’s motive is to keep the door open for a rate hike sooner later than later. If
that occurs as you know, I don’t think the economic impact will be that
great. That said, since the economy appears
to be weakening, a rate hike won’t exactly be constructive.
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 production
in this country continues to grow which is a significant geopolitical
plus. However, we have yet to see the
‘unmitigated’ positive attributed to lower oil prices by the pundits. Not surprisingly, with oil prices up, this
same crowd is trumpeting the pluses that rising prices will have on capital
spending. If they keep trying, the law
of averages says that they will eventually be right. But who will listen?
The
negatives:
(1)
a vulnerable global banking system. This week:
[a] UBS got its wrist slapped for currency
manipulation.
[b] five banks
including Citi, JP Morgan and Bank of America plead guilty to currency manipulation---but
no one goes to jail.
Unfortunately, this reverses the hopeful signs we saw last
week that the regulators may be attempting to impose justice on the too big to
fail banks. For those banks to plead
guilty [which is a first] and no one be held accountable is unconscionable.
SEC commissioner chides agency for not enforcing the
law (medium and must read):
‘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 US love
affair with debt (medium):
Which is
mathematically impossible to pay off (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.
This week
witnessed more confusion out of the Fed.
First, there were two articles published: one by the San Francisco Fed
arguing that the seasonal adjustment factors in recent economic data releases
should have been doubled in which case the economy would look normal. Later in the week, the Bureau of Economic
Analysis agreed and suggested that there will be indeed be some seasonal
adjustments to the seasonal adjustments.
However, the caveat in this exercise is that whatever increase is
applied to the first quarter seasonal adjustment may be taken from the
subsequent quarters. In short, the
overall trend wouldn’t change, it would just be less volatile. [So far, no one is suggesting that the
already poor second quarter numbers need another seasonal adjustment. But then the second quarter is over yet.]
In the second
article, the NY Fed which has been tweaking its econometric model said that the
economic outlook is great [although the spread of possible outcomes is so wide
as to be meaningless].
Add that to the
convoluted narrative in Wednesday’s release of the most recent FOMC minutes: the
Fed [a] thinks that the first quarter economic weakness was transitory, but it
is worried about the potential impact of the strong dollar, economic weakness
in growth in China and the outcome of the Greek bailout negotiations, [b] has little
support for a rate hike in June; but contends that any decision will be data
dependent and, therefore, it is not ruling out an increase in June and finally
the coup de grace, [c] is concerned about the effect of a rate hike on the
markets, in view of the increased role of
high-frequency traders, decreased inventories of bonds held by broker-dealers,
and elevated assets of bond funds---all a result of Fed/regulatory policy.
Finally, Yellen
spoke on Friday but didn’t add much to the narrative. She did say that she expects a rate hike in
2015, though provided no guidance on timing.
Judging by the Market’s reaction, investors continue to believe that it
will be later rather than sooner---perhaps at their own peril.
I am very
unclear what this all means; and I am not sure the Fed even knows. It is full of on the one hand/on the other
hand, wishy washy, afraid to make a firm statement comments, which I can only
assume were deliberate and, I think, the best evidence there is that in fact
the Fed is either clueless or realizes what it has done and is scared
s**tless.
I do have one
scenario that links this all together: the Fed knows that QE has not only not
worked but has created problems that will only get worse the longer QE
lasts. Therefore, the time has arrived
to bite the bullet which it does under the guise of projecting a stronger
economy than there is evidence to support.
Then when the consequences occur (which will be largely Market related),
it can point to all those studies showing that the economy is OK and blame the Market
reaction on high frequency traders, broker dealers and bond funds. Bear in mind this is just the cynical thoughts
of an elderly market participant.
The Fed was not
the only central banking making the news this week: [a] the Banks of England
and Japan both reiterated their undying devotion of QE, and [b] the ECB said
that it would ‘front load’ its QE. So whether
or not, the Fed starts to taper, the QE crowd is still going to have plenty of
sources for cheap money.
Finally, in a
speech Draghi re-emphasized that the ECB could not pull the EU economy out of a
ditch all by itself. Fiscal [budget and
regulatory] reforms were essential to returning to historical growth
rates. Good for him. Every government in the world should take
note, not the least of which is our own.
I think it doubtful that any economy can return to its former self until
consumer and business confidence returns and that won’t happen until the
shackles have been removed.
(4) geopolitical
risks: this week:
[a] ISIS took
Ramadi but perhaps worse is the delusional spin the administration is putting
on its ISIS strategy. http://www.powerlineblog.com/archives/2015/05/delusional-white-house-calls-isis-strategy-a-success.php
[b] the Iranian
nuke negotiations seem right on track as the Ayatollah said in a speech that
there would be no surprise inspections and no inspections of certain ‘facilities’. The spin will undoubtedly be that he is just
saying that for {Iranian} public consumption; and that is not really what will
be in the agreement. Rather than make a
sarcastic, cynical statement, I will wait till we see the agreement; if we see
it.
[c] and last
but certainly not least, in a speech Obama proclaimed that one of the great
security risks to the US is climate change.
Cue the sarcastic statement.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The key datapoints this week
were
[a] upbeat
prints of Japanese first quarter GDP and May composite PMI. Hopefully, this is a signal that perhaps
another major economy is starting to come out of the doldrums. As you know, I have been a bit cautious about
accepting these numbers at face value; however, there no reason at present to
question their validity.
[b] the EU PMI and
German business confidence were disappointing.
Not enough to deep six the prospect of a latent economic improvement but
sufficient to the leave the question open.
[c] the really
bad international economic news this week was the Chinese composite PMI; not
only because it was the third negative PMI report in a row but also because it
was just another in a steady stream of poor data from all sectors of the
economy.
Nevertheless
with both Japan and the EU showing some signs of life, our ‘muddle through’
scenario, which has been gasping for air of late, may end up being right on.
In addition,
The
Greek/Troika bailout discussions continued---and seemed to be going nowhere
until yesterday when the leaders of Greece, France and Germany met. While there was no agreement, ‘significant
progress’ was said to have been made. And
not a moment too soon; because Greece has notified the IMF that it would not be
able to make the June 6 E1.5 billion payment and the ECB met to discuss raising
the discounts applied to Greek bank assets used as collateral for loans. Maybe this latest meeting falls in historical
euro pattern of pulling victory from the jaws of defeat at the last possible
second; if so, it runs counter to every other official statement made this
week.
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, the promise for first quarter upward revisions notwithstanding. Until we start getting concrete evidence that
the economy is not slipping further, the risk remains that I may have to revise
our forecast down again.
The international
data didn’t improve the odds. While
Japan may be showing some signs of life, EU data was all negative and China was
terrible. Finally, the Greek/Troika
negotiations are nearing zero hour with no apparent resolution in sight. An agreement may still happen; but the odds
are falling and the unintended consequences by definition, unknown.
The Fed is
keeping things interesting (1) seeming to suggest from several sources that the
economy is not as bad as many think---we are just getting bad numbers and (2)
admitting that the risks associated with any rate hike are a product largely of
its own policies. I am as confused as
ever as to what these guys will do next; though I am more sure that whatever
they do it will have more impact on the Markets than it has on the economy.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications declined;
the May NAHB confidence index was below expectations; April housing starts and
building permits were very strong; May existing homes sales were a
disappointment,
(2)
consumer: month to date retail chain store sales slowed;
weekly jobless claims rose more than anticipated
(3)
industry: the April Chicago national activity index
fell versus forecasts of an advance; the May Markit flash manufacturing index
was below consensus; the May Philadelphia and Kansas City Fed manufacturing indices
were below expectations,
(4)
macroeconomic: April leading economic indicators were
up more than estimates; April CPI was,
in line; ex food and energy, it was above forecast.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 18232, S&P 2126) turned in a flattish week. Both closed above their 100 day moving average
but they were out of sync on their all-time highs, which is to say that the
S&P finished above that level while the Dow ended below.
Longer term, the
indices remained well within their uptrends across all timeframes: short term (17220-20025,
2021-2593), intermediate term (17378-23506, 1826-2593 and long term (5369-19175,
797-2138).
Volume fell on
Friday; breadth also declined. The VIX dropped
all week, finishing below its 100 day moving average and the upper boundary of
a very short term downtrend---both positives for stocks. In addition, 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.
The long
Treasury had a bit more volatile week than stocks; though the results were the
same---basically flat. It remained below
its 100 day moving average, the upper boundary of a short term downtrend and
near the lower boundary of its short term downtrend. So overall the momentum continues to the
downside.
The divergence
in performance between the stock and bond markets (the stock market rising on
weak economic numbers/easy Fed while the bond market falling presumably on better
growth and higher inflation) was clearly muted this week. My guess is that most investors have made
their bets based on available data and thus are biding their time awaiting the
next defining event.
In the meantime,
this week gold, oil and the dollar reversed their recent trends which adds to
the tension posed by the conflicting scenarios embodied in the pin action of
the equity and fixed income markets.
I have no idea
how all these factors resolve themselves.
But till they do, I think patience is needed.
As I noted
above, GLD traded back below its 100 day moving average and the neckline of its
head and shoulders pattern. Given its erratic
price movement over the last year, I am not sure that there is a message in
GLD; and if there is one, it is probably labeled ‘confused’.
Bottom line: the
Dow hasn’t made a new high in three months which itself was only fractionally
higher than the prior high; on the other hand, the S&P did make a new high
but just barely and on anemic volume.
Clearly, there
is some uncertainty among investors. The
question which I posed early in the week is, is this ‘a consolidation before a
challenge of the upper boundaries of their (the Averages) long term uptrend or are
the buyers blowing their wad trying unsuccessfully to break materially higher.’?
I feel almost
certain that, having come this far, the indices will at least make an old
school try at challenging those upper boundaries. That said, I also believe that challenges will
be unsuccessful---which, from a strictly technical viewpoint, makes the short
term risk/reward in the Market right now unattractive.
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 (18232)
finished this week about 51.0% above Fair Value (12073) while the S&P (2126)
closed 41.8% 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 seem that
recovery is taking hold in Europe, the latest PMI number notwithstanding. In addition, the Japanese economy is showing
signs of life. Unfortunately, China is
still struggling and the US ain’t so hot itself. All that said, 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.
QE continues to
be the policy du jour (England, Japan, ECB) globally; although the two recent
Fed studies along with opaque FOMC minutes and Friday’s Yellen speech may be
giving a subtle message that interest rate hikes are not that far away. Certainly, that notion is being supported by
the bond market.
We should also
be concerned about the growing number of voices pointing to the lack of
liquidity in the bond markets (lack of supply, the downsizing of bank trading)
which gained credence this week from none other than the FOMC minutes. In sum, rate increases may be closer than
once thought; irrespective of the timing, even the Fed is worried about the
lack of liquidity in the markets should that tightening process be interpreted
negatively by investors. And if it is
worried, maybe 50% in cash is not enough.
Another great
article by David Stockman on the Fed and the market (medium and a must read):
The Middle East just
keeps getting more complex. ISIS
captured Ramadi (Iraq) this week and now controls sizeable territory in Syria
and Iraq. Meanwhile, Iran’s Supreme
Leader says ‘no way, Melvin’ to any inspections of its nuclear facilities. But don’t worry about it because our
president says His Middle East strategy is working. In fact, it is working so well His next
target in assuring US security is, drumroll, climate change. If that works as well as the rest of His foreign
policy, better go buy a gas mask. That,
of course, has nothing to do with the Market---unless, that is, the bad guys
capture, disable or disrupt the flow of oil.
Friday’s joint
statement from the Greeks, French and Germans (‘significant progress’) aside,
the cold hard facts are that Greece has an E1.5 trillion IMF payment due June
5. Granted that there is a grace period
following the nonpayment; but the euros are still cutting it pretty close if
they are going to step back from the cliff.
My bottom line is that I have no idea how this resolves itself but if a
default/Grexit occurs that are apt to be unintended consequences (e.g. this
week’s statements out of the Portuguese government) that are disruptive to the
Market.
Or maybe this: UK
analyzing a Brexit (medium)
‘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.
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 18232
2126
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 47 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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