The Morning Call
5/15/15
The
Market
Technical
The indices
(DJIA 18252, S&P 2121) smoked yesterday, largely on a disappointing PPI
number (low inflation = no rate hike).
Both remained above its 100 day moving average and were back above the trend
of lower highs. In addition, the S&P
closed slightly above its all-time high, though the Dow fell short of its
comparable level.
Longer term, the
indices continue to trade well within their uptrends across all timeframes:
short term (17168-19965, 2014-2995), intermediate term (17315-22432, 1820-2591)
and long term (5369-18873, 797-2135).
Volume was up
slightly; breadth was a positive. The
VIX declined 7%, closing below its 100 day moving average, below the upper
boundary of a very short term downtrend and within a short trading range---all
a plus for stocks.
With the S&P
having closed above its prior high, I ran an update on our internal model after
the close last night. In a Universe of
140 stocks, 11 finished higher than their prior highs, 17 were at or near their
all-time highs and 117 remained below. Now
if I were you and I saw these numbers, I would have two questions (1) is his
model’s filtering system completely broken, that is, is it just spitting out
garbage companies that don’t deserve to be making new highs? You know what our Portfolios look like; so I will
leave that judgment to you, (2) did the study split hairs, to wit, if a stock
was within a point or so of its all-time high, was in counted as a negative? The answer is that the stock had to be 5% off
its high to qualify as a negative. Clearly, this worm’s eye view of the Market in
no way supports current Index price levels.
So much for
sentiment indicators (short):
The long
Treasury was up only slightly, despite the PPI report and its rousing reception
by the equity market. It finished near
the bottom of its short term downtrend and below its 100 day moving average.
GLD had another
good day, confusing since lower inflation usually leads to lower gold
prices. It ended above its 100 day
moving average and right on the neckline of its head and shoulders
formation. If that line is challenged
successfully, a short term uptrend would be set.
Ray Dalio on
gold (2 minute video):
On the other
hand, oil was off slightly; something you would expect if the economy is
weakening. However, it was also
influenced by the Saudi’s taking a self-proclaimed victory lap on having put
the high cost shale drillers out of business.
The dollar finished
below the lower boundary of its short term uptrend for the second
day---negating that trend and resetting to a short term trading range.
Bottom line: the
very short term technical picture is potentially clarifying as both Averages
closed above the trend line of lower highs.
If they remain there or higher, that trend line would be negated. They still need to get above their prior
highs before a very short uptrend can be proclaimed. That isn’t a big deal for the S&P since
it has already done it; however, the Dow still has some work to do.
The discordant performance
of bonds and gold remain an issue---at least with respect to the longevity of
any uptrend that may develop IF they continue to reflect the potential for higher
inflation, higher interest rates or stronger economy. I am still a bit confused
by these mixed messages, though as I noted yesterday the growing lack of market
liquidity is in that mix somewhere. On
the other hand, I wouldn’t rule out the possibility that some of the recent
volatility was simply a reflex from the prior over extension of price.
All that said, I
still believe that (1) the risk reward in stock market at this point is in the
favor of risk and (2) if the Averages will be capped on the upside by the upper
boundaries of their long term uptrends which I believe represent formidable
resistance.
More
on the seasonal performance of stocks (short):
Fundamental
Headlines
Yesterday’s
US economic news was mixed: the weekly jobless claims number was better than
anticipated, but April PPI suggested deflation---and that comes on the heels of
Wednesday’s report that April export and import prices had declined. Given that employment is a lagging indicator,
the PPI and export/import prices provide more information on what is going on
now. Both offer additional evidence that
our forecast for a slowing rate of economic growth is right on.
No
datapoints on the global economy. There was
a speech by the Greek finance minister suggesting that the maturity of the debt
of his country held by other sovereigns, agencies and financial institution
should extended far into the future (key canned laughter)
The
latest, laughable but not funny (medium):
Bottom line: our
forecast for slowed economic growth was reinforced this week by some pretty pronounced
deflation stats. While it sent a thrill up
the equity boys’ legs, the fixed income and gold markets were not nearly as
excited. If it were a one day phenomenon,
I wouldn’t give it much of a second thought. But the divergence and volatility that have
gripped all the markets in the last couple of weeks is confusing, at least to
me. Unfortunately, the resolution to
this confusion will involve clarity on economic and corporate profit growth and
the level of interest rates (discount factor) both of which have an impact on
stock prices.
I am not predicting
a recession (though growth is demonstratively slowing) or a continuing rise in
interest rates (though rates are dramatically off their lows percentage wise) and
I certainly can’t quantify the magnitude of impact that declining liquidity will
ultimately have on the markets---though I am increasing convinced that the
latter will at some point will be an issue.
But as I noted yesterday, the
volatility in all markets is suggesting that investors are starting to rethink
the economic/valuation models.
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.
In the interest
of being fair and balanced, I try to include opinions that differ from
mine. The article below argues that
higher rates are good for stocks. But
his key assumption is that higher rates stem from a better economy. So what if the economy continues to
deteriorate (the E part of P/E) but interest rates rise because everyone
finally realizes that QE is a shell game (the discount factor of P/E)?
Here is an expansion on
the economic growth part of the thesis that I outlined above (medium):
Investment
strategy thoughts from Keith McCullough---one of my favorites (medium):
Subscriber Alert
During
our regular fundamental updated analysis of ConocoPhillips, it failed to meet
the minimum financial hurdles necessary for inclusion in our Dividend Growth
and High Yield Portfolios. Hence, COP is
being Removed from both Universes and will be Sold from each Portfolio at the
market open.
Thoughts on Investing
A Dozen Things I’ve Learned from Michael Price about Investing
1. “Of course, the macro
questions are the hardest ones to figure out. I am not trained to be an
economist, and I don’t think economists get it anyway. I am left
with the bottoms-up, 10Q by 10Q analysis, and hope I have enough sense of where
we are in the cycle…” Michael
Price is another successful investor who ignores macro forecasts in favor
of a bottoms-up analysis.
2. “Never, never pay attention
to what the market is doing. … Stay away from the crowd.” Mr. Market is not always wise. He sometimes will sell you
a stock at a bargain or pay you more than it is worth. The art of knowing
the difference is value
investing. Falling in with the crowd will put you under the sway of Mr. Market
because Mr. Market is the crowd.
3. “The key question in
investing is, what is it worth, and what am I paying for it? Intrinsic
value is what a businessman would pay for total control of the business
with full due diligence and a big bank line. The biggest indicator to me is
where the fully controlled position trades, not where the market trades it or
where the stock trades relative to comparables.” By thinking like a business owner Michael Price
becomes a better investor. Buying share of stock in a business
is owning a partial stake in a business. If a share of stock is not a
partial stake in a business, what exactly is it? Anyone who thinks a
share of stock is a piece of paper that people trade back and forth is in deep
trouble as an investor.
4. “We like to buy a security
only if we think it is selling for at least 25% less than its market value.” It is refreshing to hear an investor assign a number of a
“margin of safety”. My assumption is that this 25% figure is a rule
of thumb. Many value investors would say that the margin of safety they
are looking for is relative based on the risk of the particular business (e.g.,
the risk of a bakery business is not the same as the risk of a biotechnology
company).
5. “If you really [want]
to find value, you [must] do original work, digging through stuff no one else
[wants] to look at. …The really important thing is to eliminate the Wall Street
consensus, the Wall Street research. You need to understand where the company
is in the world and what the competition is for the products, whether the
products are any good, and whether or not the company has any pricing power or
barriers to entry. … Think about the business, think about what you see
without any input from Wall Street, do [your own] primary research.” To generate alpha in investing you must
occasionally be contrarian and be right about that contrarian view. In
short, you must find a mispriced bet. To find a mispriced bet you are best
positioned if you are looking where fewer people are looking.
6. “You can get lost in the
spreadsheets. You can’t rely on the projections that you put in the
spreadsheets alone… Depending too much on the Excel spreadsheet and
forecast of discounted cash flows is a big mistake.” Extrapolating the past into the future is a parlor
trick favored by consultants and analysts. This process may seem logical to
many people but it is pregnant with danger. Complex adaptive systems
produce changes that can’t be extrapolated. Things that can’t go on forever,
don’t.
7. “The worst mistake investors
make is taking their profits too soon, and their losses too long.” This is classic “loss aversion” at work. People
hate taking a loss even if it is sunk. Unless you are a trained investor your
emotions can get the best of you.
8. “A good time to start in
[the investing] business is when markets are terrible…. We wait for bad news… I
love to read about losses.” A value
investor likes prices to fall, especially when they have dry powder and can
take advantage of the drop. A classic value investor looks at a price drop of a
stock they like as a chance to buy more, whereas the ordinary investor may
panic and sell.
9. “I couldn’t care less about
getting zero on my cash. That’s ammunition.” Cash has optionality. Yes, that optionality has a
cost which includes inflation. Especially when inflation is low and
prices of stocks are high, the price of the optionality can be well worth
paying.
10. “For rates of return,
smaller is better. Returning excess returns at $20-$30 billion is not so
easy.” The more money an
investor must put to work, the harder it is to generate investing alpha. Many
opportunities are small in size relative to a big fund. People only get
so many investable ideas during the course of a year and some of them are not
very big. Another risk is psychological since sometimes an investor will
compromise their principles on a big investment just to be able to put money to
work.
11. “We know it’s easy to get
swept away in a growth market. But I’ve been in this business more than 25
years and I’ve watched investors figure out a way to justify incredible
multiples, only to see valuations collapse back to the underlying worth of
the company. The key in the business is weathering the bear markets, not
outperforming the bull markets.” Value investing shines brightest when stocks are falling
in price since they were purchased based on value. Value investing
principles can also help you avoid the flip side of bubbles (panics).
12. “A lot of people have the
brains. It is the judgment with the brains that matters, and that comes
with experience and from thinking about things in the right way.” Intelligence without judgment and the right temperament
won’t make someone a good investor. Intelligence can actually be a problem
since the smarter you think you are, the more you may get into trouble trying
to predict things that are not predictable.
News on Stocks in Our Portfolios
Economics
This Week’s Data
The
NY Fed’s May manufacturing index came in at 3.09 versus expectations of 5.0.
Other
Politics
Domestic
Obama’s fast track
Trans Pacific partnership bill regains momentum in the senate (medium):
Germany not
happy with the ECB, Draghi or QE (medium):
Quote of the day
(short):
International War Against Radical Islam
More
on the Iran nuke deal (medium):
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