The Closing Bell
7/25/15
Number two granddaughter and number three grandson arrive today for a
week. That means Six Flags, the aquarium,
putt putt golf, etc. No Morning Calls
next week; though clearly with the Market in its present precarious state, I will
be paying close attention. Any actions
will be reported via Subscriber Alerts.
Statistical
Summary
Current Economic Forecast
2014
Real
Growth in Gross Domestic Product +2.6
Inflation
(revised) +0.1%
Corporate
Profits +3.7%
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 17652-20574
Intermediate Term Uptrend 17855-23995
Long Term Uptrend 5369-19241
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2083-3062
Intermediate
Term Uptrend 1872-2638
Long Term Uptrend 797-2145
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 53%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy provides no upward bias to equity valuations. The dataflow
this week was paltry but mostly upbeat: above estimates: June existing home
sales, June leading economic indicators, weekly mortgage and purchase
applications, weekly jobless claims, the July Kansas City Fed manufacturing
index and the Chicago National activity Index; below estimates: month to date
retail chain store sales, June new home sales; in line with estimates: the July
Markit flash manufacturing index.
There were several
important indicators (existing [+] and new home [-] sales, leading economic indicators
[+]) which were weighed to the plus side.
So overall, total as well as primary indicators this week were positive. However, there were several anecdotal reports
that were not so upbeat: Caterpillar’s global sales (not good anywhere) and the
National Retail Federation estimate of 2015 retail sales (lower). These taint the more encouraging dataflow,
diminishing the degree of its positiveness (is that a word?) Therefore, my conclusion from last week
remains the same: the recent trend towards stabilization continues but that
doesn’t mean that growth is accelerating---it just means that it has stopped
decelerating. Our forecast remains:
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 conflicting profit incentives
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 never saw the ‘unmitigated’ positive forecast by the pundits
when oil prices initially cratered. Last
week marked the beginning of a second round of whackage---and still no ‘unmitigated’
positive.
The
negatives:
(1)
a vulnerable global banking system. Once again JP Morgan is at the top of the
bankster fraud hit parade. This week’s
episode entails the bank’s agreement to pay $388 million to settle a suit by
investors who claim it misled them on the safety of mortgage backed securities
that it sold them.
That said, there was also two huge pieces of good news
this week:
[a] the Fed finalized the capital surcharges for the
too big to fail banks, creating an additional $200 billion cushion,
[b] this week, Wall Street will begin complying with
the ‘Volcker rule’ banning taxpayer insured banks from making bets with their
own money {i.e. prop trading desks}.
Clearly both of these measures will be very helpful in
mitigating my concerns and preventing the implosion in financial institutions
experienced in 2007.
My concern here is that: [a] investors ultimately
lose confidence in our financial institutions 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 from either subprime
debt problems in the student loan or auto markets or turmoil in the EU financial
system resulting from a Greek default or exit from the EU.
(2) fiscal
policy. No news this week on the
national level. We did get more from
Puerto Rico: [a] the island’s credit was downgraded by the major rating
services and [b] UBS announced that it was no longer accepting PR bonds as collateral. Not a positive for our muni bond ETF’s in our
ETF Portfolio.
(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,
consensus seemed to build [based on the pin action in gold, the dollar and
bonds] for a September Fed rate hike.
May be. But the inflation data
doesn’t suggest it nor does the US/global macroeconomic data [i.e. all weak]. While a rate increase doesn’t make economic sense,
as I suggested last week, Yellen et al may want to do it just to prove that
they know how.
Who do you
believe, commodities or the Fed (medium and a must read):
Not that it
matters, because the Fed is already too late in the timing of its transition to
tighter monetary policy. Unfortunately,
all those QE inspired reserves still sit on the bank balance sheet and all that
debt still sits on the Fed’s balance sheet---waiting for investors to recognize
the futility of the QEInfinity and the harm that it has done to the US economy
via the mispricing and misallocation of assets.
The same applies to global
asset mispricing and misallocation (medium):
You know my
bottom line: sooner or later, the price will be paid for asset mispricing and
misallocation. The longer it takes and
the greater the magnitude of QE, the more the pain.
(4) geopolitical
risks: little occurred of consequence this week other than the now raging
debate over whether the Iran deal is good or bad. Again, leaving aside the long term political
and foreign policy issues, an approval of the treaty would have several short
term positive economic impacts: [a] oil prices are likely to decline further as
a result of Iran being able to export its production, and [b] relief from
current trade sanctions are likely to lift Iranian economic activity which will
benefit global growth.
Liar, liar
pants on fire (medium):
Counterpoint
from the former head of Israeli internal security (medium):
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The headlines this week were:
[a] the Greek
struggle to meet the terms set out by the Troika in order to receive bailout
funds. So far, they have done so; this
week approving a second bill complying additional Troika mandated reforms. There are still those that believe that
Greece will ultimately be unable or unwilling to fulfill the terms necessary to
remain within the EU. However for the
moment, the potential threat of default has been taken off the table.
This is a very
pessimistic assessment of not just the Greek, but the entire EU, economic
situation. I would not accept it in
full; but it does come from the source that was reasonably accurate in the
latest act of the Greek tragedy (medium):
[b] in China, markets has remained stable and
at recovery levels---which, I guess, answers the question that I posed two weeks
ago: who is stronger, a totalitarian government or the free market? Like Greece, it has removed immediate
concerns about the consequences of a Market crash.
And, how much
impact did all that money China spent really have?
However, two
important issues remain. Short term, if
the Market turmoil was reflective of a rapidly decelerating Chinese economy,
then the resulting consequences will be much less susceptible to the whims of
imperial edit simply because of the magnitude of China’s trade with the rest of
the world. Not that the government can’t
or won’t lie about their own import/export numbers; but they can’t control what
China’s trading partners report. What I
am driving at here is that if, in fact, China’s economy is slowing that will impact
global growth. And seemingly to put a
finer point on this issue, several disappointing stats were reported this week
[see below].
The second but
longer term issue is, does the Chinese government’s short term victory over
stock market pricing spell the end to that country’s economic liberalization. If so, its consequences for the long term
economic growth in China is likely to be negative and of long duration.
In other
economic news, Chinese business sentiment plunged 14%; Italian and British retail
sales declined while those in Canada rose.
Both the Chinese and EU June Markit flash manufacturing PMI’s were disappointing.
In sum, our global
economic ‘muddling through’ assumption has improved somewhat from two weeks
ago. I am still concerned that
conditions in either Greece or China (but especially China) could suddenly worsen
and again threaten our Economic Model.
Bottom line: the US economy continues to recover from the
doldrums of the first five and half months of the year, putting the threat of
recession even further behind us. On the
other hand, this improvement has not been robust enough to assume a return to
the recovery rate of this cycle much less to the average secular rate of the
past several decades.
The
international data, in particular that out of China, did little to demonstrate
any kind of pick up in global economic growth. Indeed if anything, the Chinese stats suggest
that the Chinese stock market, pre-government interference, could well have
been signaling impending trouble in one of our biggest trading partners.
This week’s
data:
(1)
housing: June existing home sales were strong; June new
home sales were awful; weekly mortgage and purchase applications were up,
(2)
consumer: month to date retail chain store sales growth
declined from the prior week; weekly jobless claims fell more than anticipated,
(3)
industry: the June Chicago National Activity Index came
in better than forecast; the July Kansas City Fed manufacturing index remained
in negative territory but improved slightly,
(4)
macroeconomic: June leading economic indicators were
well ahead of estimates; the July Markit flash manufacturing PMI was in line.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17569, S&P 2079) fell this week, falling on a number of earnings
disappointments and more weak economic data out of China. In the process,
(1) the
Dow [a] fell below its 100 day moving average and was there long enough to re-set that MA from support to
resistance, [b] dropped below its 200 day moving average; if it remains there
through the close on Wednesday, that MA will re-set from support to resistance,
[c] declined below the lower boundary of its intermediate term uptrend; if it
remains below that boundary through the close on Tuesday, the intermediate term
trend will re-set from up to a trading range and [d] fell below the lower
boundary of its short term trading range; if it remains there through the close
on Tuesday, the short term trend will re-set from up to a trading range.
(2) the
S&P [a] dropped below its 100 day moving average; if it remains there
through the close on Wednesday, it will re-set from support to resistance, [b]
declined below the lower boundary of its short term uptrend; if it remains
there through the close on Tuesday, it will re-set from up to a trading range.
Longer term, the indices are, for the moment, within
their uptrends across all timeframes: short term (17652-20574, 2083-3062),
intermediate term (17856-23995, 1872-2638) and long term (5369-19241,
797-2145).
Volume rose; breadth
was negative. The VIX was up 9%, but is
still below its 100 day moving average and remains within a short term trading
range, an intermediate term downtrend and a long term downtrend. So far, it is not confirming the pin action
of the Averages.
The long
Treasury was up, but still closed below its 100 day moving average and within
its short term downtrend. However, it
has established a very short term uptrend.
Surprise,
surprise, GLD was actually up, though it remained below its 100 day moving
average and within short, intermediate and long term downtrends.
And this from
Jim Grant (medium):
Oil was down, finishing
below its 100 day moving average and below the lower boundaries of its [a]
short term trading range; if it closes below that boundary on Tuesday, the
short term trend will re-set from a trading range to a downtrend, [b]
intermediate term trading range; if it remains below that boundary through the
close on Wednesday, the intermediate term trend will re-set from a trading
range to a downtrend.
The dollar
lifted, remaining above [a] its 100 day moving average, [b] the lower boundaries
of its short and intermediate term trading ranges and [c] the lower boundary of
a very short term uptrend.
Bottom line: clearly,
following Thursday and Friday’s negative pin action, the indices are now
challenging numerous support levels. As I
noted in Friday’s Morning Call, a break of these trend levels would sustain the
notion that the Market is in a topping process.
However, that is getting way ahead of events. It will take a good deal more whackage to complete
the successful challenge of those trends.
So for now, best to stay patient and focus just on the follow through of
the assaults on those trends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17568)
finished this week about 44.7% above Fair Value (12137) while the S&P (2079)
closed 38.0% overvalued (1506). 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.
The US economic
data continues to support our forecast and hence the economic assumptions in our
Valuation Model.
Ignore the
screams about a Market crash and just concentrate on the poor economic data
(medium):
Overseas, the
economic data has been nothing to cheer about, in particular, some very rough
numbers out of China. That suggests that
while the Chinese government’s smack down of its equity market may have been a
rousing success, it can do nothing to alter the impact of slowing economic
activity on global/US growth.
Still, the
financial/market risks posed by the Greek political/economic situation clearly
subsided last week. That is not to say
that they have gone away; but there is at least a reasonable probability that
nothing untoward is coming from that direction.
Finally, with
the downgrade of Puerto Rican debt, odds have likely increased of an outcome in
the government’s negotiations with creditors that incorporates principal
loss. Whether this would include all PR
public debt and how much spill over there might be to other US city, county and
state municipal debt issues is not clear at this time. I am not so much worried
about any fallout’s impact on equity markets as I am about the potential effect
on the muni market---to which our ETF Portfolio has exposure.
Bottom line: the
assumptions in our Economic Model are unchanged. 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 for equities.
The assumptions
in our Valuation Model have not changed either; though at this moment, there
appears to be more events (greater than expected decline in Chinese economic activity;
miscalculations by one or more central banks that would upset markets) that
could lower those assumptions than raise them.
That said, our Model’s current calculated Fair Values under the best
assumptions are so far below current valuations that a simple process of mean
reversion is all that is necessary to bring Market prices down significantly.
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; but
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.
More on earnings
estimates and ‘beats’ (short):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 7/31/15 12137
1506
Close this week 17568
2079
Over Valuation vs. 7/31 Close
5% overvalued 12743 1581
10%
overvalued 13350 1656
15%
overvalued 13957 1731
20%
overvalued 14564 1807
25%
overvalued 15171 1882
30%
overvalued 15778 1957
35%
overvalued 16384 2027
40%
overvalued 16991 2108
45%overvalued 17598 2183
50%overvalued 18205 2259
Under Valuation vs. 7/31 Close
5%
undervalued 11530
1430
10%undervalued 10923 1355
15%undervalued 10316 1280
* 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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