The Closing Bell
8/15/15
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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 Trading Range 2043-2135
Intermediate
Term Uptrend 1886-2650
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 weighed to the positive: above estimates: weekly mortgage applications,
month to date retail chain store sales, July retail sales, the July small
business optimism index, the July export and import prices, July PPI and July
industrial production; below estimates: weekly purchase applications, weekly
jobless claims, June wholesale and business inventories/sales, second quarter
nonfarm productivity and August consumer sentiment; in line with estimates: none.
The primary
indicators included July retail sales (+), July industrial production (+) and second
quarter nonfarm productivity (-). So in
total, the stats as well as the primary indicators while mixed still were upbeat. 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 here and, I might add, anywhere else in the world. And remember that this latest decline is
occurring at exactly the supposed ‘peak’ of the summer driving season. It seems logical then that the risk is rising
that these lower prices have been brought on not just by increased supplies but
because of declining demand---and that feeds the global economic slowdown [deflation]
story.
The
negatives:
(1) a
vulnerable global banking system. This
week Credit Suisse and Barclays entered settlement
negotiations with the SEC and NY attorney general over facilitating unfair
advantages, incorrect stock pricing and other wrongdoing in their dark pools.
Credit Suisse is in talks to pay a fine in the high tens of millions, which
would be the largest fine ever levied against a private trading venue operator,
while Barclays' discussions also suggest a large fine.
In addition,
five more banks have settled U.S. investor lawsuits tied to a global
currency-rigging scandal, which claimed the institutions conspired to
manipulate the $5.3T-a-day foreign-exchange market. HSBC, Barclays, Goldman
Sachs, BNP Paribas, Royal Bank of Scotland now join a list of nine firms which
previously settled the class actions, bringing the total amount investors have
recovered to $2B.
Thus, it would seem that despite ongoing efforts to curb their
misconduct, the banksters are still giving it the old college try. That said, our ruling class has attempted to
put 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 should over the long term help
mitigate the ability of the banksters to endanger the financial system.
(2) fiscal/regulatory
policy.
Budget deficit
is down to 2.2% of GDP (medium):
On the other
hand, debt to GDP has risen to levels that are likely unsustainable, [a]
demonstrating that, like QE, deficit spending hasn’t really worked in
stimulating economic activity and [b] hence calling into question the viability
and effectiveness of any future attempts at stimulus.
(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 over
whether the Fed will raise rates in September took a sudden turn to the
negative this week with China’s decision to devalue the yuan. As you know, an appreciating currency [like a
yuan devaluation versus the dollar] and higher interest rates [like a Fed rate
hike] tend to strengthen a currency which in turn, at least in the short term, have
a negative impact on a country’s economic growth. Hence, a September rate on top of the yuan devaluation
would further increase jeopardize the already fragile US economic progress.
Not that a rate
increase would make any difference one way or the other economically. As you know, I have long maintained that QE [except
QE1] did little to nothing to stimulate the economy. While some investors worry that a rate hike
will hasten a recession, I can’t imagine one 25 basis point rate increase hike
making that kind of difference.
I think that
the real worry is that the Fed has once again botched the transition from easy
to a more normal monetary policy and that all the ills from multiple QE’s [asset
mispricing and misallocation] may be coming home to roost. Indeed, this would fit with my long term
thesis 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 effect.
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.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. This week:
[a] whether
Faustian or not, the Greek’s made and approved their deal with the Troika. The deal also received approval from most of
the parties within the Troika, though at this writing not from the Germans who
continue to piss and moan that the terms are not tough enough. So Greece should be receiving E86 billion
bailout funds shortly. The near term
result is that the tail risk associated with a Grexit or a default is off the
table.
[b] unless you
are living in a hole, you know that the key development this week was the Chinese
government’s devaluation of the yuan. By itself, it was a minor adjustment {circa
3%}. But it was one of those kind of
surprises that few expect but everyone recognizes after the fact that not only
does it make sense but it could have a significant impact on the global
economy, to wit, that the Chinese economy is not growing as fast as many assumed
and that liquidity injections {QE} haven’t worked either to stimulate the
economy or to devalue the currency.
There are two
issues going forward:
{i} since most
pundits agree that the yuan was overvalued by about 10%, will the Chinese
government continue the devaluation process until that number is met? On Thursday, the government said that there
would be no further move to deduce the value of the yuan; and on Friday, it
allowed the yuan to appreciate slightly.
But we all know that these guys lie; plus almost every government does
that with respect to currency valuation.
That is, they swear there will be no devaluation up until the mille
second before they do it.
Meanwhile, the
Chinese are not backing off their (stock) plunge protection policy (medium):
{ii} will the
Chinese move to direct intervention versus the current generally accepted QE
back door devaluation be the event that triggers recognition by investors and
governments that QE hasn’t, isn’t and won’t work---with the resulting loss of
faith in central bankers and the adjustment in asset price valuations?
Another gloomy
piece from David Stockman, this time on China (medium):
[c] elsewhere
around the globe, EU second quarter GDP was up less than anticipated with the
three biggest countries {German, France, Italy} all reporting disappointing
numbers; and Japanese consumer sentiment was the lowest in six months.
In sum, I am
holding to our global economic ‘muddling through’ assumption; though China is
something of a wild card.
A more sanguine
view (short):
Bottom line: the US economy dataflow continues to reflect
very sluggish growth in the US economy.
However, the flow of anecdotal numbers remains discouraging; and perhaps
more important, if the latest moves by the Chinese government are a signal that
its economy is growing much slower than currently assumed, that has negative
implication for the global as well as own outlook. Indeed, the biggest economic risk to our forecast
is growth problems in the rest of the world.
This week’s
data:
(1)
housing: weekly mortgage applications rose 0.1% while
purchase applications fell 4.0%,
(2)
consumer: month to date retail chain store sales growth
rose from the prior week; July retail sales advanced slightly more than
expected; weekly jobless claims were up more than estimates; August consumer
sentiment was below consensus,
(3)
industry: July industrial production was better than
anticipated; the July small business optimism index was slightly better than
forecast; June wholesale inventories were up but sales fell; as did business inventories
and sales,
(4)
macroeconomic: second quarter nonfarm productivity was
less than consensus; July export and import prices were down a bit less than
expected; July PPI rose more than expected; ex food and energy, it was also
above estimates.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17477, S&P 2091) quietly ended a volatile week. The Dow ended [a] below its 100 and 200 day
moving averages, both of which represent resistance, [b] in a short term
trading range {17385-18295}, [c] in an intermediate term trading range
{15842-18295} and [d] in a long term uptrend {5369-19175}.
The S&P
finished below [a] its 100 day moving average, now resistance, [b] within a
short term trading range {2043-2135} and [c] within intermediate term uptrend {1886-2650}
and a long term uptrend {797-2145}.
Volume fell;
breadth was positive. The VIX was down, 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 remains strong, ending [a] above its 100 day moving average, now support,
[b] within short and intermediate term trading ranges and [c] above the lower
boundary of a very short term uptrend.
GLD declined on
Friday, remaining below its 100 day moving average and in short, intermediate and
long term downtrends. However, during
the week, it managed to negate a very short term downtrend. While not terribly significant, it could be
signal that a bottom is being made.
Oil continues to
crash, finishing below its 100 day moving average and within short and
intermediate term downtrends. Tellingly, it is plunging during the summer
driving season which is generally the peak oil consumption time of the year.
The dollar rose,
closing below its 100 day moving average, now resistance, and within short and
intermediate term trading ranges.
Bottom line: this
week, the S&P began to re-sync with the Dow to the downside. The very least one could say is that this
signals a loss of upside momentum. So the
bulls have some work to do to re-gain control.
However, this move could be also indicate that a Market top has been
made. It is going to take more technical
damage (both indices trading below their 200 day moving averages and re-setting
their short term trends to down) before we can make that call with any
confidence. This is not a technical environment in which I
would be buying stocks.
Bonds at the
moment are suggesting no Fed rate hike and/or a weakening economy. They are receiving support from oil, which
seems to be screaming deflation. Here
too it is a too soon to make that call.
But for the first time is some time, stocks, bonds and oil are pointing
in the same direction---slowing global growth accompanied perhaps by a whiff of
deflation.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17477)
finished this week about 43.6% above Fair Value (12169) while the S&P (2091)
closed 38.5% 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. But the flow of negative
anecdotal economic stats hasn’t let up; and that is a growing concern,
especially now that the Chinese have, at least, implicitly let it be known that
all is not well in the Middle Kingdom.
Unfortunately, conditions are not much better in the rest of the
world. The risk being that try, as they
might, American business and labor simply can’t overcome the hurdles presented
by declining global economic activity. Sooner
or later that gets reflected in earnings and, hence, the Market.
The Fed continues
to send mixed signals to the Market via committee participants’ public
statements. As you know, I believe that they
are doing so because they know that they are in a box of their own making,
haven’t a clue how to extricate themselves so they prevaricate and pray for a
last minute reprieve from heaven. The
odds, of course, is that is not apt to happen.
But as long as a majority of investors believe their routine, then it is
so.
The problem is
that Fed policy has done little else than cause severe distortions in asset
pricing and allocation and when it starts reversing, it is apt to be as painful
as euphoria was as it was induced. In my
opinion, several things could trigger that ‘reversing’ process: (1) no matter what
the Fed does about rates, the consequences will be negative and/or (2) if the
Chinese keep their devaluation process going, it could precipitate the ‘emperor’s
new clothes’ catalyst which finally brings the realization that QEInfinity has
been a losing proposition.
Net, net, my two
biggest concerns for the Markets are (1) the economic effects 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 17477
2091
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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