The Closing Bell
9/5/15
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 Downtrend 17019-17938
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 2022-2086
Intermediate
Term Uptrend 1904-2677
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 again to the negative side of mixed: above estimates: weekly mortgage and purchase applications, August
light vehicle sales, August retail chain store sales, the Markit services PMI, the
ISM services index, second quarter nonfarm productivity and unit labor costs; below
estimates: month to date retail chain store sales, the August ADP private
payroll report, August nonfarm payrolls, weekly jobless claims, August Chicago
PMI, August Dallas Fed manufacturing index, August ISM manufacturing index,
July construction spending and July factory orders; in line with estimates: the
August Markit manufacturing PMI.
The primary
indicators included August ISM services index (+), August vehicle sales (+), August
retail chain store sales (+), August ISM manufacturing index (-), July
construction spending (-), July factory orders (-) and August nonfarm payrolls
(-). In sum, the balance of both the total
indicators as well as the primary indicators was negative.
Overseas, the
Chinese government spent another the week intervening in both its stock and
currency markets in an attempt to stem losses.
It was joined in the currency market by several emerging market central
banks---mostly those with a lot of trade with China or whose national income is
heavily dependent on commodities, oil in particular. On top of this, the international the
economic data was just awful.
Just to insure
that everyone knows that it is ‘data dependent’ (read clueless). Fed vice chair Fischer made hawkish comments
at last Saturday’s Jackson Hole summit; basically reversing the prior week’s
statement from the NY Fed head. I covered
that in our Morning Calls and re-hash a bit of it below. But the bottom line is that monetary policy
(except for QE1) has not, is not and is not apt to be of any help to our
economy; and fretting over a measly 25 basis point rate hike is the height of
mental masturbation. All QE has done is
create asset mispricing and misallocation of major proportions.
In summary, both
total and primary stats were negative, the Fed is a danger to itself and the US
economy and the global economy provided no relief. For the time being, I am staying with our
forecast but it appears increasing likely that I will have to revise it down
again.
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.
A neutral and getting less so:
(1)
our improving energy picture. Oil production in this country continues to
grow which is a significant geopolitical plus.
On the other hand, there has been no ‘unmitigated’ positive from lower
oil prices. In addition, [a] there is
mounting evidence that the continuing decline in oil prices is at least partly
a function of falling demand and [b] lower oil prices have had a pronounced
negative impact on both countries in which oil is a primary export and highly
leveraged oil companies. With regard to
the former, the loss of income in those countries is forcing them to liquidate
foreign reserves {read US Treasuries} to sustain their internal budgets. Problems in either oil exports or oil company
balance sheets could feed the global economic slowdown [deflation] story.
The
negatives:
(1)
a vulnerable global banking system. A week free of bankster misdeeds.
The risk of a
financial crisis is higher than previously estimated (medium):
‘My concern here.....that: [a] investors
ultimately lose confidence in our financial institutions and refuse to invest
in America 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, particularly in the international financial
system.’
(2) fiscal/regulatory
policy. A week free of ruling class misdeeds---they were too busy approving the
nuke deal with Iran.
(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 Fed keeps
jerking the Markets around. Last
Saturday, Fed vice chair Fischer in a speech in Jackson Hole put the
possibility of a September Fed rate hike back on the table---right after a
speech prior in the week by NY Fed chief Dudley, who said that a rise in the
Fed Funds rate was ‘less compelling’, given the turmoil in the international
markets.
Confused. That is OK, because the Fed is too. Its problem is that it has waited too long to
begin a tightening of monetary policy; and now that it more or less committed
to a hike in September, the markets are in the process of doing it for them in
the form of foreign central banks selling US Treasuries to bolster their
economies and relieve downward pressure on their currencies. That in turn puts upward pressure on interest
rates and downward pressure on money supply.
Goldman on the
problems in the emerging markets (medium):
Ironically
enough, all those dollars the Fed pumped out in multiple QE’s that chased yield
into foreign assets are now coming home to roost so to speak. In short, the markets aren’t waiting for the
Fed to unwind QE, they have assumed control of the process. So a rate hike now will only add upward
pressure on interest rates. Indeed, if
the Fed still wants to stay reasonably accommodative, its most obvious response
would be QEIV.
The point of
all this is that at the precise time the Fed is making a half assed move to
tighten [rate hike], the markets are speeding up the process at an
uncomfortably high rate---if your concern is US economic growth. That said, I have
long argued that unwinding QE [of which, a rate hike is part] won’t make a
tinker’s damn because it had so little economic effect when it was being
implemented. So all this gnashing of
teeth over the impact of a rate hike on the economy is nothing but a false
flag. What the Fed is worried about is
its effect on the Markets which were hugely influenced by QE. Unfortunately for the Fed it now appears that
it is losing control of its own monetary policy. Also, unfortunately, the payback will most
likely come in the one area that QE did have an impact---asset pricing and
allocation.
Today’s must
read (medium):
What QE did impact
(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.
IMF points to the not so pleasant
end of QE (medium):
(4) geopolitical
risks: the Iranian nuke deal, the secession vote in eastern Ukraine and the hot
war in the Middle East remain the trouble spots. The news this week was that [a] Obama has the
votes to guarantee approval of the deal {He has the votes to support His veto
of a rejection of the treaty} and [b] Russia now has troops and equipment on the
ground in Syria. I think both only
exacerbate tensions in the Middle East and hence the potential to escalate and
spill over into the economic arena.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. Lots of overseas economic news
this week: August Japanese industrial output was below forecast, twin August
Chinese manufacturing indices fell to the lowest levels in three years; EU
August Markit manufacturing PMI declined; South Korean exports declined the
most in six years, Brazil’s economy is sinking so fast that it is in danger of
a credit downgrade and July German factory and August UK retail sales were
disappointing. The only positive stats
were August EU Markit composite PMI and the Japanese Markit services PMI.
Clearly, these numbers don’t suggest any improvement in a slowing global
economy.
David Stockman on Brazil
(medium):
China remained
center stage:
[a] as it
continued its battle to cower sellers in its stock market {i} arresting several
high profile investors and {ii} ‘encouraging’ nine Chinese brokerages to pledge
thirty billion yuan to purchase stocks,
[b] imposed reserve
requirements on futures positions to stem the downward pressure on the yuan and
along with other emerging markets maintained persistent sales of US Treasuries
to shore up its {their} currencies.
It is the latter that is of
greatest concern to the US---a subject I covered in (3) above.
Clearly,
the problems being experienced in the rest of the world keep the yellow
flashing on our global ‘muddling through’ assumption.
Bottom line: the US economic data continues to reflect very
sluggish growth in the US economy.
However, global economic trends are still deteriorating; and the Fed
remains paralyzed by fear of the consequences of prior policy mistakes. These are the biggest economic risks to our forecast. The warning light is flashing.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up,
(2)
consumer: month to date retail chain store sales growth
was less than expected but August retail chain store sales were encouraging;
August light vehicle sales were ahead of consensus; the August ADP private
payrolls report came in below estimates as did August nonfarm payrolls; weekly
jobless claims rose more than anticipated,
(3)
industry: the August Chicago PMI was slightly below
forecast; the Dallas Fed manufacturing index was down much more than
anticipated; the August Markit manufacturing PMI was in line while the services
PMI was a tad better than estimates; the August ISM manufacturing index was
disappointing while the services index was a modest beat; July construction
spending was below expectations; July factory orders were one half of forecast,
(4)
macroeconomic: second quarter nonfarm productivity was
up more than consensus while unit labor costs fell more than anticipated; the
July trade deficit was slightly below estimates.
The
Market-Disciplined Investing
Technical
This week, the
indices (DJIA 16102, S&P 1921) continued on the roller coaster that they
have been on. The Dow ended [a] below
its 100 and 200 day moving averages, both of which represent resistance, [b] in
a short term downtrend {17019-17938}, [c] in an intermediate term trading range
{15842-18295}and [d] in a long term uptrend {5369-19175}.
The S&P
finished [a] below its 100 and 200 day moving averages, both of which represent
resistance, [b] below the upper boundary of a very short term downtrend, [c] in
a short term downtrend {2022-2086}, [d] within an intermediate term uptrend {1904-2677}
and [e] a long term uptrend {797-2145}.
Both of the
Averages finished below the lower boundary of the developing pennant formations
that I have been following: if they remain there through the close on Tuesday,
the pennant formations will be voided.
Usually, when this occurs, there is a further move in the direction of
the break (in this case, down). Furthermore,
the indices have marked four lower highs, setting up a very short term downtrend. Finally, the S&P closed well below the 1970
level.
On the other
hand, the slide this week did not re-challenge the intermediate term trends of either
of the Averages. As long as those trends
remain intact, this recent move down is simply a correction in a bull
market.
Volume was up on
Friday; breadth was negative, with the flow of funds indicator remaining
negative for almost the entire week. The VIX continues to behave positively
(negatively for stocks), ending [a] above its 100 day moving average, now
support, [b] within a short term uptrend, [c] within an intermediate term
trading range {it remains well above the upper boundary of its former intermediate
term downtrend} and [d] a long term trading range.
The long
Treasury managed to stabilize this week after a rough performance in the prior
week. It finished above its 100 day
moving average and within short and intermediate term trading ranges. As you know, I believe that the recent (negative)
pin action in this market has not reflected expectations of higher interest
rates or a stronger economy, but rather are, at least partially, a function of
sales coming from attempts by the Chinese and other emerging market central
banks to stabilize their currencies and finance their flagging economies. That doesn’t make TLT’s price less down. But it is not, in my opinion, suggestive of
stronger forthcoming economic growth.
Indeed, it is likely the opposite.
After a brief
ray of hope, GLD returned to its old disappointing ways---breaking that very
short term uptrend, which I had hoped signaled that a bottom had been
made. Not so. GLD remains in downtrends across all
timeframes and below its 100 day moving average. It can still build a bottom were it to fail
to successfully challenge its July/August lows.
But that is yet to be seen.
Oil seems to
have stabilized, at least temporarily, in a short term trading range. But this week’s trading was weak; so I am not
sure that we will see any additional momentum to the upside---barring some extraordinary
exogenous event. It remains below its
100 day moving average and within intermediate and long term downtrends.
The dollar declined
on Friday, closing right on its 100 day moving average, which is now
resistance, and within short and intermediate term trading ranges.
Bottom line: the
key technical takeaways this week were (1) the failure of the S&P to regain
the 1970 level and (2) both Averages building a short term pennant formation
and then breaking to the downside---which usually means more downside. And that probably means another challenge (re-test)
of the lower boundaries of their intermediate term trends.
If those trends
are negated, then the technicals go from a flashing yellow to a flashing red
light. On the other hand, a successful re-test
will likely end this current bout of downside pressure. While fundamentally I think the Market has
much lower to go, the charts may make me wrong---again.
The long
Treasury continues to challenge the notion that there will be no Fed rate hike
and no recession. However, as I noted above,
there are short term outside factors, only tangentially related to the US
economy, driving Treasury bonds down (yields up)---that being the selling of
Treasury securities by China and other emerging markets attempting to defend
their currencies.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16102)
finished this week about 31.9% above Fair Value (12201) while the S&P (1921)
closed 26.9% overvalued (1513). 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---although the stats from the last two weeks have been nothing about
which to feel all warm and fuzzy. If
this trend continues, I may have to lower our economic forecast again.
Not helping
matters are the turmoil in the Chinese currency and stock markets as well as
the numbers from the rest of the world---the concern obviously being that the
slowdown in the global economy will wash on to our shores. Clearly, this poses a risk to our outlook. More importantly for the Market, the risk is
that since many Street forecasts are more optimistic than our own; so if they are
revised down, it will likely be accompanied by lower Valuation estimates.
The Fed gave the
Market another head fake this week as vice chair Fischer suggested that a
September rate hike was still a real possibility. This ‘on the one hand/on the other hand’ ‘data
dependent’ mumbo jumbo has been going on for months with an uncomfortable
regularity. And it is meaningless
because the Fed with all its QE efforts has done very little to help the
economy. So hanging on every datapoint
like it is the magic key to the future is lunacy. The point being that the one place this group
of self-important, high powered economists have had almost no impact is the
economy. So being ‘data dependent’ about
the economy is giving themselves, and anyone else that believes that fairy tale,
a hand job.
Of course, they
are not stupid; and they know all the above; and they know that the one place
QE has been effective is in creating a giant asset bubble. So their ‘data dependency’ is not on the
economy but on the Markets. And since
Markets are volatile, so are the Fed’s policy statements. But the unfortunate result of fixating on the
Markets instead of the economy is that the Fed has once again screwed the
economy by botching the transition to normalized monetary policy and, worse, further
magnifying the gross mispricing and misallocation of assets---and that is no
mumbo jumbo.
Net, net, my two
biggest concerns for the Markets are (1) the economic effects of a slowing
global economy and (2) Fed [central bank] policy actions whatever that are or
are not and the loss of confidence in those actions.
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. Unfortunately,
our assumptions may be too optimistic, making matters worse.
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; turmoil in the emerging markets and commodities; 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 any further bounce in stock 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 9/30/15 12201
1513
Close this week 16102
1921
Over Valuation vs. 9/30 Close
5% overvalued 12811 1588
10%
overvalued 13421 1664
15%
overvalued 14031 1739
20%
overvalued 14641 1815
25%
overvalued 15251 1891
30%
overvalued 15881 1966
35%
overvalued 16471 2042
40%
overvalued 17081 2118
Under Valuation vs. 9/30 Close
5%
undervalued 11590
1437
10%undervalued 10980 1361
15%undervalued 10370 1286
* 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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