The Closing Bell
7/11/15
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 17551-20375
Intermediate Term Uptrend 17763-23895
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 2070-3049
Intermediate
Term Uptrend 1861-2629
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 53%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy provides no upward bias to equity valuations. The dataflow
this week, what there was of it, was mixed: above estimates: weekly mortgage
and purchase applications, month to date and June retail chain store sales and
the May US trade deficit; below estimates: the June Markit PMI services index, May
wholesale inventories/sales, consumer credit and weekly jobless claims; in line
with estimates: the June ISM nonmanufacturing index.
There were few important
indicators (the ISM nonmanufacturing index, the Markit PMI services index and
May wholesale inventories/sales) and they were mixed/negative. But to be fair
this week’s data didn’t add a lot to our understanding of the condition of the
economy. Coupled with last week’s mixed
results this represents a step back from the gangbusters week we had two weeks
ago. But that kind of erratic pattern is
exactly what one would expect in a sluggishly growing economy. To be sure, the numbers have improved over
the last month; but they had to, else I would have had to consider lowering our
growth forecast even more or worse forecasting recession. Net, net, I remain satisfied that our current
forecast is right on target:
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 were cratering. Not
surprisingly, when oil prices started to recover somewhat, this same crowd trumpeted
the pluses that rising prices will have on capital spending. This week, prices started getting whacked
again on news of rising inventories and the prospects of an Iranian nuke deal
that will allow them to start exporting their oil again. I guess now the narrative will return to the ‘unmitigated’
positives of lower oil prices. I am still waiting.
The
negatives:
(1)
a vulnerable global banking system. This week JP Morgan, our ‘fortress bank’, found
its dick in the wringer once again. This
time it is paying a fine for the improper collection and selling of consumer
credit card information.
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. Not exactly a US fiscal policy
issue, but one that is still of concern is the current financial dilemma of
Puerto Rico. As I have reported, the
governor has stated that the state can’t payback its debts. His latest position is that the island needs
to renegotiate the terms of its massive debt.
While not likely to impact the US economy in any meaningful way, there may
be some probability of disruptions in the muni bond market [a] not just in
Puerto Rican debt but also in other weak municipal credits, [b] especially if investor
psychology turns less sanguine.
(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.
On Wednesday, the
FOMC released the minutes of its last meeting.
While this is some disagreement, I interpreted them as slightly more
hawkish than the statement issued following the meeting. Confirming that view in a speech on Friday,
Yellen said that she expects an interest rate rise this year.
That said, I
don’t know how anyone can make a judgment regarding potential Fed action at its
September meeting or any other time as long as the current level of uncertainty
surrounding the Greek bail out and the Chinese market plunge remains.
On the other
hand, the Chinese central bank is scrambling to do everything possible to stem
the decline in its securities’ market.
And the ECB had made it clear that its ‘whatever it takes’ policy is
alive and well and will be pursued with vigor should the outcome of the Greek
bailout negotiations lead to financial unrest.
So far, the Chinese experience is showing once again that monetary
policy is of little help in most circumstances.
We await judgment on the potential ECB/Greek turmoil.
This study is a
follow up to the Rogoff/Reinhart research that suggested that a country’s
growth slows as its debt to GDP rises above 90%. In this study, the authors posit that
economic growth is inversely related to growth in the financial sector. (medium and a must read):
(4) geopolitical
risks: tensions continue in Ukraine and there is no letup in the fighting in
the Middle East. However, they are
taking a back seat to the Greek standoff.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. The headlines this week were:
[a] the
continuing standoff between the Troika and the Greeks over a bail out agreement. This drama is playing out like an Alfred Hitchcock
movie in which you never know what will happen next. As of this moment, the Greeks have offered to
comply with the Troika’s demands on raising taxes and reducing pension. We will get the response from the EU Monday
morning, though as of last night, it didn’t sound all that promising. Markets continue to trade as though there
will be an agreement. Could be; although
I am not so sure that a Grexit wouldn’t be the best solution for the Greeks in
the long run.
This is a bit
long but is a great discussion from my ‘go
to’ expert on the whole bail out process, Tsipras’ disastrous leadership and
why this isn’t over (long but a must read):
[b] the carnage
in the Chinese stock market. While I have
noted that there is little chance of a direct impact on our
economy/market---since foreign investors own a small portion of the total
Chinese market---there are indirect effects: {i} this week, we saw the yen jump
as a recipient of ‘safe haven’ trades.
That puts the yen ‘carry’ trade at risk which would have a bearing on
global money managers portfolios, {ii} the decline in the Chinese markets in
part reflects a slowdown in economic activity (witness the simultaneous drop in
agricultural and industrials commodities) which impacts all of that country’s
trading partners and {iii} since we can never trust the data we get out of
China, there may be factors driving the market down that we don’t even know
about.
Here is a
counterpoint from Stephen Roach (medium):
http://www.slate.com/articles/business/moneybox/2015/07/china_stock_meltdown_why_its_actual_economy_will_be_just_fine.single.html
In other
economic news, the UK released two conflicting measures of its manufacturing sector,
while German factory orders were disappointing. Neither are particularly
encouraging given that the UK and Germany have two of the strongest economies
in Europe. Certainly, there is nothing
to suggest that our own economy will get any kind of boost from Europe.
‘Muddling
through’ remains the assumption for the global economy in our Economic Model
with the proviso that a Greek default/exit or a sharp decline in economic
activity in China would likely force a re-evaluation occurs of our own
forecast. This remains the biggest risk to forecast.
Bottom line: while the US economic news for the last two
weeks has been mixed, it is still an improvement from the first eighteen weeks
of the year. Thus, it is positive in
that it, hopefully, is taking the recession scenario off the table. But, in my opinion, that in no way suggests
any acceleration in our growth prospects above the rates that existed in the preceding
couple of years.
The
international data did little to demonstrate any kind of pick up in global
economic growth. Indeed, the potential risks associated with a Grexit or a
significant decline in China’s economic growth rate would be a threat to our
own forecast.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up,
(2)
consumer: month to date retail chain store sales were
up; June retail chain store sales improved; weekly jobless claims rose more
than forecast; consumer credit increased less than consensus,
(3)
industry: the June PMI services index was below
forecast, while the June ISM nonmanufacturing index was in line; May wholesale
inventories rose 0.8% but sales were up only 0.3%,
(4)
macroeconomic: the May US trade deficit was lower [better]
than estimates.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17760, S&P 2076) had a real roller coaster ride this week, suffering
severe whackage after the NO vote in the Greek referendum and the plunge in the
Chinese markets and then rallying on good news from both fronts as well as
short covering. In the process, they
challenged a number of key support levels, then voided those breaks: both
finished back above their 200 day moving averages and both closed above the
lower boundaries of their short term uptrends.
However, they remain below their 100 day moving averages and the Dow
ended below the lower boundary of its intermediate term uptrend. If it finishes there on Monday, that trend
will be negated. At this point, the key remains
follow through; though in which direction is the question.
Longer term, the
indices are for the moment within their uptrends across all timeframes: short
term (17551-20375, 2070-3049), intermediate term (17763-23895, 1861-2629) and
long term (5369-19175, 797-2138).
Volume fell on Friday,
not especially encouraging for the bulls.
Breadth rose. The VIX dropped 15%,
bouncing off of the upper boundary of its intermediate term downtrend but still
above its 100 day moving average and the depressed levels of two weeks ago.
The long
Treasury was down 1.5%, closing below its 100 day moving average and below the
upper boundary of its short term downtrend---clearly losing its recent cache as
a safe haven.
GLD continues to
do nothing, having done nothing when other safe haven bets were responding last
week. Oil traded higher but remains
below its 100 day moving average and near the lower boundary of its short term
trading range; while the dollar declined, closing below its 100 day moving
average and the lower boundary of a very short term downtrend.
Bottom line: after
the extreme volatility this week, it seems hard to believe that the S&P ended
right on its close from the week before.
At the moment the indices are in a very short term range bounded by
their 100 day moving averages on the upside and the lower boundaries of their
short term uptrends on the downside. On
a slightly long term basis they have been flat since the first of the
year.
With the
headlines as emotionally packed as they have been, it is likely that purely
technical factors will continue to take a back seat. Next week those headlines include the Greek
bail out (which despite Tsipras’ capitulation, is not a done deal), the Chinese
markets (which are being torn asunder by government attempts to control prices)
and earnings season (which starts in earnest).
Nonetheless, it should be interesting watching the bulls and bears
continue to battle it out in the present trading range.
On a short term trading
basis, the bias has switched to the upside with the risk being the indices’
lower boundaries of their short term uptrends and the upside marked by the
upper boundaries of their long term uptrends.
Longer term, however, the spread between the upper and lower boundaries
of the Averages’ long term uptrends should make investors cautious about making
any investments at current levels.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17760)
finished this week about 46.3% above Fair Value (12137) while the S&P (2076)
closed 37.8% 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 preceding
two weeks of mixed data properly reflects, I think, our forecast of no
recession but decelerating growth.
Hence, there is no need to challenge the longer term growth of
productive capacity assumption in our Valuation Model.
The Fed has
already done its part to assure ‘a botched…transition from easy to tight money’---irrespective
of what it does in September. It is now
facing the probability that unless it gets very lucky, (1) if it tightens, it
will run the risk of hampering or even stopping what sluggish growth the US
economy currently has or (2) if it doesn’t tighten, it still may have to
implement QEIV due to the aforementioned economic lethargy and/or events in
Greece/China that produce a shock that would necessitate a further infusion of
liquidity to maintain stability within our financial institutions---and that is
just what we need: more pricing distortion in the securities market and more
asset misallocation.
Of course,
nothing says botched central planning like the current clusterf**k unfolding in
China. After originally encouraging investment is stocks, the Chinese
government now attempting to stem the current decline in prices by mandating
stock buying by government related entities, banning trading by some of the
biggest shareholders, allowing more than one half of the listed companies to
suspend trading in their stocks and carrying on a publicity campaign demonizing
anyone that might be selling.
And the latest
gambit---brokers refusing to accept Sell orders (short):
Of course, save
for the order of magnitude, its efforts at distorting asset pricing and
allocation is no different than the US, Japanese and EU central banks. I believe that sooner or later these efforts
to control free market price/asset allocation discovery will ultimately bring
pain to most markets. The only question
is when.
The Greek
bailout dilemma keeps not getting resolved as the parties continue to dance
around a solution. Clearly, as long as
the dance goes on, there is a probability of an agreement; and the more ‘last
chances’ the Greeks are given, the higher that probability. At the moment, the
Greeks are again at a ‘last chance’ moment.
The difference this time is that they appeared to have given in to the
Troika’s demands. There is a Sunday
meeting to appraise the new Greek plan.
So we will know more Monday morning.
As I noted
above, I think that there is strong long term economic argument for a
Grexit. On the other hand, it would seem
like a potentially dangerous political decision to allow Greece to exit the EU,
given the chance of a Russian overture should that occur. I have
no idea how this crisis gets resolved; though if history is any guide it
somehow will end positively, even if it doesn’t correct failed fiscal policies that
caused the problem in the first place.
Further, I remain unclear as to the ultimate consequences of a default
or Grexit; but I suspect that they would impact the Markets negatively.
Finally, on not
quite so grand a scale as Greece, the chickens of fiscal mismanagement are
coming home to roost in Puerto Rico. The
focus of the government is now on debt relief (lowering interest rates,
extending maturities) which if successful will have a clear impact on the value
of Puerto Rican municipal debt. It could
likely lead to some spill over into all junk rated municipal debt especially in
any period of market malaise.
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.
The assumptions
in our Valuation Model have not changed either; though there are scenarios (Grexit/China)
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; 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 valuation (short):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 7/31/15 12137
1506
Close this week 17760
2076
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
55%
overvalued 18812 2334
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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