The Closing Bell
8/8/15
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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 Trading Range 17385-18295
Intermediate Term Trading Range 15842-18295
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 2087-3026
Intermediate
Term Uptrend 1882-2646
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 very upbeat: above estimates: weekly mortgage and purchase
applications, month to date retail chain store sales, June personal income,
July consumer credit, weekly jobless claims, July nonfarm payrolls, July light
vehicle sales, July ISM nonmanufacturing index, July factory orders and the
July Markit services index; below estimates: July ISM manufacturing index, June
construction spending, June retail chain store sales and the June trade deficit;
in line with estimates: June personal spending and the July Markit PMI.
The primary
indicators included June personal income (+) and personal spending (0), July
ISM manufacturing (-) and nonmanufacturing (+) indices, July factory orders (+),
June construction spending (-), June retail chain store sales (-), July nonfarm
payrolls (+). So in total the stats were
quite positive while the more important indicators were slightly upbeat. (This, by the way, follows a week in which the
numbers were disappointing.) In short, the
data pretty much reflects 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 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. This
week saw a continuation of a second leg lower---and still no ‘unmitigated’
positive.
The
negatives:
(1)
a vulnerable global banking system. This week witnessed the beginning of a DOJ
probe of Deutsche Bank into money laundering on behalf of Russian clients. So there has been no letup in the banksters’
criminal behavior.
That said, as I noted two weeks ago, our ruling class is at
least putting a governor on financial institutions ability to wreak economic havoc
by imposing the capital surcharges for the too big to fail banks and commencing
enforcing compliance with the ‘Volcker rule’ [banning taxpayer insured banks
from making bets with their own money {i.e. prop trading desks}]. These measures have clearly helped mitigate
the ability of the banksters to endanger the financial system.
(2) fiscal/regulatory
policy. Once again, Obama snubbed the constitution by passing legislation via
executive fiat---this time His new ‘climate change’ initiative. The social policy aspect aside, this will [a]
cost industry an arm and a leg which will be passed on to you and me and [b]
lead to the layoff of thousands of coal miners, with all the attendant ‘safety
net’ expenses to say nothing of the human costs. Of course this will likely be challenged in
the courts; but so was Obamacare and look how that turned out.
There was
another development in Puerto Rico, to wit, a default of a bond issue. To date, this hasn’t had much if any impact
on the muni market in general and on our muni ETF’s in particular.
(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.
The debate
continues over whether the Fed will raise rates in September. This week, the Atlanta Fed chief, who is a
moderate, weighed in on the side of a hike---which seemed to steer the
narrative in that direction; and the bond market models are now said to be
pricing in a 52% chance of an increase.
As you know, I am
not convinced that it will make any difference one way or the other
economically; because QE didn’t make much difference on the upside. However, there is a school of thought that
says that a rate hike will hasten a recession.
I can’t imagine one 25 basis point rate hike making that kind of
difference. If this economy is heading
for a dip [which in my opinion has a much stronger likelihood than a pickup in
growth], it will happen with or without a rate hike,
Which gets back
to part of my central point thesis with respect to the Fed--- it will botch the
transition for easy to normal monetary policy; and in fact, this time around,
it has already done it.
The Fed, in my
opinion, is 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. And a 25 basis point rise
in the Fed Funds rate won’t make a tinker’s damn to the economy.
From Fed
whisperer Hilsenrath (short):
Another part of
my thesis is that while a return to normal monetary policy won’t impact the
economy, it will have a dramatic influence on the Markets since that is where
QE has had the most affect. What bothers
me at this point is that a Fed rate increase has been beat to death in the
media for the last couple of months, so surely it is well discounted in the Markets.
Nevertheless, I
believe that somewhere out there is an event that will trigger investor recognition
of the futility of the QEInfinity and the harm that it has done to the US
economy via the mispricing and misallocation of assets. I would have thought that the latest data out
of Japan, i.e. the weakest growth in real wages in six years, would register
somewhere in investors’ minds that even super-duper QEInfinity not only hasn’t
worked but has caused pain and suffering.
But that too has been ignored.
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.
A must read
from Doug Kass (medium):
(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.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. This week:
[a] the Greek’s
are having a difficult time getting/staying in compliance with the wishes of
the Troika. Though so far they have been
able to do so. From all that I have seen
and read, it makes no long term economic sense for the Greeks to grovel before
the eurocrats. But that is their decision;
and as long as there are no stumbles, this situation will likely remain on the
back burner.
[b] the Chinese government continued
attempting to muscle the Markets with mixed results. After its initial efforts/successes, I
thought that they had indeed buffaloed investors/sellers. But that now appears to have been a bit
premature. Chinese Markets continue
volatile despite ever more onerous policies impositions {banning trading by a
US hedge fund and more restrictions on short sellers}; and the Chinese economy continues
to generate data {government filters notwithstanding} suggesting that all is not
well---which if true will only add to the growth problem the globe already has.
On Friday, an outside
economist estimated that the Chinese government has injected $1.3 trillion into the economy via
bailouts and stimulus.
In other
economic news, the July EU Markit PMI was above expectations, while retail
sales were dismal. German industrial
orders were up but actual production fell. Construction spending in the UK
declined.
In sum, I am
holding to our global economic ‘muddling through’ assumption; though China is
something of a wild card.
Bottom line: the US economy dataflow continues to improve from
the stats generated in the first five and half months of the year; though the
anecdotal numbers are not that encouraging.
At the moment, I think that (1) our forecast of a very slowly growing economy
is right on, (2) nothing that is going to improve that performance and much
that could derail it and (3) indeed, the anecdotal evidence is making me
nervous that even our reduced forecast may be too optimistic.
The
international data did little to demonstrate any kind of pick up in global
economic growth. Indeed, the numbers out
of Japan and the EU paint a picture of economic frailty, while uncertainty related
to the Chinese Markets’ volatility and current strength of the economy is
concerning. The biggest risk to our
economy is growth problems in the rest of the world.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up,
(2)
consumer: month to date retail chain store sales growth
rose from the prior week, while the numbers for the month of June were
disappointing; June personal income was higher than anticipated while spending
was in line; July consumer credit jumped markedly; July light vehicle sales
were above expectations; the July ADP private payroll report was not good; July
nonfarm payrolls rose slightly more than estimates; weekly jobless claims were
up less than consensus,
(3)
industry: the July ISM manufacturing index was below
forecast, while the nonmanufacturing index was well ahead; the July Markit PMI
was in line while the services PMI was above of expectations; June construction
spending was well below estimates; July factory orders were slightly better
than forecast,
(4)
macroeconomic: the June US trade deficit was slightly
higher than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17373, S&P 2077) had another rough day on Friday. The Dow ended [a] below its 100 and 200 day moving
averages, both of which represent resistance, [b] below the lower boundary of
its recently re-set short term trading range {17385-18295}; if it remains there
through the close on Tuesday, the short term trend will re-set to down, [c] in
an intermediate term trading range {15842-18295} and [d] in a long term uptrend
{5369-19175}.
For the second
day, the S&P finished below [a] its 100 day moving average; if it remains
there through the close on Monday, it will revert from support to resistance
and [b] the lower boundary of its short term uptrend; if it remains there
through the close on Monday, it will re-set to a short term trading range. For the moment, it remains in uptrends across
all timeframes (2097-3076, 1882-2648, 797-2145).
What do stocks
do after seven down days in a row (short)?
Volume fell;
breadth was negative. The VIX was down---a
bit unusual for a down Market day---closing below its 100 day moving average
and remaining within a short term trading range, an intermediate term downtrend
and a long term trading range.
The long
Treasury was strong for a second day, ending above [a] its 100 day moving
average; if it remains there through the close on Monday, it will revert from
resistance to support, [b] the upper boundary of its short term downtrend; if
it remains there through the close on Monday, it will re-set to a short term
trading range and [c] the lower boundary of a very short term uptrend.
GLD was up fractionally,
but remained below its 100 day moving average and in downtrends across all
timeframes.
Oil fell 3%, finishing
below its 100 day moving average and within short and intermediate term downtrends.
The dollar also declined, remaining above its 100 day moving average and within
short and intermediate term trading ranges.
Bottom line: participants
in both the stock and bond markets are battling it out at key technical
junctions. In the stock market, pressure
has been to the downside for the last week with considerable technical damage
having been done to the Dow. The
S&P, which is much more reflective of stocks in general, is doing better
than the DJIA; but it too has broken some key support levels. Until these two Averages are back in sync, I am
hesitant to suggest a change in trend.
However, clearly some serious work needs to be done by the bulls to
avoid a technical breakdown.
The bond boys
are in a food fight over whether the Fed is going to hike rates and/or whether the
economy is slowing. Trading over the
last two days suggest that the no hike/economic weakness crowd in winning the
argument. That said, a couple of days’ worth
of trading is hardly a trend. But given
that multiple trends could potentially be changing direction is cause to pay
more attention.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17373)
finished this week about 42.7% above Fair Value (12169) while the S&P (2077)
closed 37.6% overvalued (1509). 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. However, as I have been
documenting over the last couple of weeks there has been a disturbing increase
in the number of negative anecdotal economic stats. Ordinarily, these bits of information are
outliers and have little macroeconomic impact.
But currently, they are growing in number and appear to be having an effect
on the stock performance of individual companies/industries. Cumulatively they can (though not always) be
the driving force behind the internal deterioration in Market strength and
breadth. Whether that is happening now
is a matter of debate; but it is reaching critical mass as a Market concern.
In addition, the
international economic data has been nothing to cheer about whether from China,
Japan, the EU or the emerging markets, suggesting that any expectation for
outside aid to our own sluggish economy is likely ill founded.
The Fed keeps
playing ‘hide the weenie’ over a potential rate hike. Honestly, I think that they are scared to
death that they have waited too long to begin the transition to a normal monetary
policy; and as you know, I think that they have every cause to be. In my opinion, no matter what they do now, it
will have negative consequences. I am
not sure but it seems to me that investors are also starting to figure that
out. As you know, I have long
maintained that since QE had little to no effect on the economy, its absence
will also have little to no effect.
Unfortunately, QE did have a huge impact on the Markets and any negative
Fed actions from here will likely have a commensurate impact on them.
Net, net, my two
biggest concerns for the Markets are (1) the economic affects of a slowing
global economy and (2) Fed policy actions whatever that are or are not.
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.
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 8/31/15 12169
1509
Close this week 17373
2077
Over Valuation vs. 8/31 Close
5% overvalued 12777 1584
10%
overvalued 13385 1659
15%
overvalued 13994 1735
20%
overvalued 14602 1810
25%
overvalued 15211 1886
30%
overvalued 15819 1961
35%
overvalued 16428 2037
40%
overvalued 17036 2112
45%overvalued 17645 2188
50%overvalued 18253 2263
Under Valuation vs. 8/31 Close
5%
undervalued 11560
1433
10%undervalued 10952 1358
15%undervalued 10343 1282
* 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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