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 16989-17908
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 2018-2084
Intermediate
Term Uptrend 1909-2682
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 quite negative---though not so much so among the primary
indicators: above estimates: the July
Department of Labor job openings reports, the August budget deficit and August
PPI; below estimates: weekly mortgage and purchase applications, weekly jobless
claims, the August small business optimism index, July wholesale inventories
and sales, the initial September consumer sentiment indicator and August import
and export prices; in line with estimates: month to date retail chain store
sales.
The primary
indicators included August PPI (+) and July wholesale inventories and sales (-);
so evenly matched among these numbers. There
was one bit of anecdotal evidence---the final tally of the S&P second
quarter corporate revenues, which were off 3%+.
In addition, our ruling class is at it again---this time threatening
another government shutdown. I score
this as the third week in a row of negative data.
Overseas, the data
flow remained lousy, the Chinese government continued intervening in both its
stock and currency markets, the Japanese government is threatening another QE
and multiple new parties are getting involved in the Syrian conflict. There was one bit of good news: both China
and Japan pledged to lower taxes. This
isn’t the first time that they have promised to do it, then didn’t. But I will take good news however I can get
it.
The Fed was
quiet this week ahead of its meeting next week.
I say quiet. There weren’t any
officials out making comments. However,
Fed mouthpiece Hilsenrath crawfished on his prediction that the Fed would raise
rates at their meeting. That makes sense
to me given the dataflow. On the other
hand, I don’t think that a decision either way will make a hill of beans to the
economy. Indeed, I am not sure it will
make any difference to the Markets since they seem to be taking the unwinding
of QE into their own hands. On the other
hand, it could exacerbate that process.
In summary, (1) the
economic stats both here and abroad were poor, (2) in my opinion, the Fed has
reached the point where virtually any action it takes will only make Market
conditions worse, (3) the turmoil in Syria is escalating and (4) now our ruling
class is talking government shutdown.
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.
However, there has been no ‘unmitigated’ economic positive for the US from
lower oil prices. In addition, lower oil
prices have had a pronounced negative impact in countries in which oil is a
primary export. Loss of oil revenues is
negative for national income and tax receipts. Aside from feeding
recessionary/deflationary forces, it also forces governments to sell reserves
to cover the loss of income. In doing
so, much of those reserves being liquidated are US Treasuries which puts upward
pressure on US interest rates. Further, taken
by itself, it shrinks money supply which is deflationary in its implications.
The
negatives:
(1)
a vulnerable global banking system. They just can’t help themselves. This week New York regulators sent letters to
primary Treasury dealers seeking information regarding the manipulation of bond
auctions. Meanwhile the Boston public
employee pension fund have sued those dealers alleging manipulation.
This is a must read article on the risks posed by too big
to fail banks with large operations in emerging markets.
More on the
problem of inter bank credit (short):
‘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. If you can believe it, another government shutdown seems a
possibility. It seems to stem primarily from
the controversy over funding Planned Parenthood; that is, many lawmakers are
unwilling to vote for any continuing resolution that contains funding for that
agency. I can understand the
political/social/moral issue; but I am not sure risking exacerbating a
weakening economy is the best way to address it.
(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 was on
radio silence this week [a blessing] ahead of next week’s FOMC meeting;
although just to keep the state of confusion at elevated levels, Fed whisperer
Hilsenrath walked back his prediction that the Fed would raise rates next week. As you know, I don’t think it makes a tinker’s
damn one way or the other. My thesis remains:
[a] QE {except
QEI} has had little impact on the economy; so unwinding it will have an equally
small effect on the economy,
[b] however, QE
led to significant asset mispricing and misallocation; unwinding it will have
an equally significant effect on asset prices,
[c] in any
case, the Fed has once again waited too long to begin the process on monetary
normalization. That compounds their asset
mispricing problem because the Markets appear to be taking matters into their own
hands and they will be less circumspect in correcting the pricing problem,
[d] the Fed
knows that it has made a mistake, but appears to think that its only
alternative is to bulls**t the Markets and pray for luck. The danger here is that in a desperate
attempt to extricate itself from the problem, it may make another equally
disastrous misjudgment and only make matters worse.
Here is an
argument that the Fed has been sly like a fox, keeping investor attention on
interest rates while slamming the brakes on money supply growth. It has merit.
On the other hand, a shrinking money supply could be a manifestation of the
flood of foreign Treasury sales {aggravating deflationary pressures} (medium):
Further support
(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.
How is this for central bank money
printing (short)?
(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 the growing Syrian
refugee problem which has now prompted Western Europe [the primary recipient of
those refugees] to get involved in the government’s conflict with ISIS. In
addition, Iran [our bosom buddies in the nuke treaty] sent more ground troops
to Syria. Too many cooks……exacerbate tensions and hence raise the potential to
escalate the violence and/or the geographic scope of the war.
The latest
(medium):
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. Lots of overseas economic stats
this week: the good news: August German
exports and imports improved; Italian industrial output increased; second
quarter EU GDP was up 0.4% versus expectations of up 0.3%; the bad news: August Chinese imports plunged, exports off
5.5%; August Chinese CPI rose 2% but PPI fell 5.9%; German CPI and PPI
declined; Spanish CPI dropped; second quarter Japanese GDP dropped 1.2%; July
Japanese machinery orders were down 3.5%; French manufacturing and industrial
production both fell; UK trade numbers, industrial production and manufacturing
production all declined; S&P downgraded Brazil’s credit rating to junk. On balance---not so hot.
Ground zero in Canada’s
recession (medium):
There was some
government response to the weakening data:
the good news: both China and Japan pledged to lower taxes; the bad
news: a Japanese official predicted more QE; China reportedly sold $94 billion
US Treasuries in August, has spent 600 billion yuan to date in stock market
‘plunge protection’ and further tightened capital controls.
In sum, the
international economic news was, with a couple of exceptions, lousy and the
government actions to counter it was, with a notable exception, not
constructive.
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 data continues to reflect very sluggish
growth in the economy. In addition
, global
economic trends are still deteriorating; and the Fed remains paralyzed by fear
of the consequences of prior policy mistakes.
The latter two 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
down,
(2)
consumer: month to date retail chain store sales grew
at the same pace as last week; the July Department of Labor jobs openings report
was very upbeat; weekly jobless claims fell less than anticipated; the initial September
consumer sentiment number plunged 6 points,
(3)
industry: the August small business optimism index was
slightly below forecast; July wholesale inventories and sales were
disappointments,
(4)
macroeconomic: both August import and export prices
were down more than consensus; both the August headline and ex food and energy reports
were higher than forecast, the August US budget deficit was $64.4 billion down
from $149.2 billion in July.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16433, S&P 1961) had another quiet calm (up) day. The Dow ended [a] below its 100 and 200 day
moving averages, both of which represent resistance, [b] in a short term
downtrend {16989-17908}, [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 {2018-2086}, [d] within an intermediate term uptrend
{1909-2682} and [e] a long term uptrend {797-2145}. In addition, it closed between the lower boundary
of a very short term uptrend [series of higher lows] and 1970, a gap of about 9
points---so one of these boundaries are apt to break in the near term. I want stocks to get out of this range and then
see if there is any technical clarity.
Volume was down;
breadth mixed. The VIX fell 5%, but still ended [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. As long as remains roughly above the 20
level, uncertainty is at elevated levels.
The long
Treasury rose, remaining above its 100 day moving average, leaving it as
support and finished within short and intermediate term trading ranges.
GLD fell, closing
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 (104). But that is yet to be seen.
Oil increased another
2%, but stayed below its 100 day moving average and within a short term trading
range and intermediate and long term downtrends.
The dollar fell,
closing below its 100 day moving average, which is now resistance, and within
short and intermediate term trading ranges.
Bottom line: the
Averages remain (1) on a long term basis, within a very wide gap between the
lower boundaries of their intermediate term trends and the upper boundaries of
the short term downtrends and (2) on a short term basis, in a much narrow zone
marked by S&P 1970 on the upside and the trend of higher lows on the downside.
The quiet late
week trading was likely a result of investors going to the sidelines ahead of
not just the FOMC meeting but similar meetings by the central banks of Japan
and Switzerland next week. If correct,
then trading should be calm in the first days of next week, then pick up later
with the conclusion of the FOMC meeting and Friday’s quadruple witching.
That said, I
continue to think that trying to decipher short term direction in a highly
volatile but trendless Market is an exercise in futility. However, longer term, as long as the lower
boundaries of the indices intermediate term trends hold, the Market is in a
simple correction in a bull market.
The long
Treasury’s pin action continues to suggest a Fed rate hike and a stronger
economy. As you know, I don’t think that
this scenario will occur.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16433)
finished this week about 34.6% above Fair Value (12201) while the S&P (1961)
closed 29.6% 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---although we now have three weeks in a
row of relatively weak stats. Another
three or so weeks of this kind of performance, I may have to lower our economic
forecast again.
Not helping
matters are 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 also poses a risk to our
outlook. More importantly for the
Market, the risk is that many Street forecasts are more optimistic than our own;
and if they are revised down, it will likely be accompanied by lower Valuation
estimates.
The Fed was
quiet this week; but that doesn’t alter the fact that (1) it has pursued a
policy that has created another asset bubble, (2) it has waited too long to attempt
to correct that mistake, (3) and any further policy error move from here runs of
the risk making the problem even worse. Of course, the latter maybe irrelevant,
because the Markets appear to have started to self-correct and that will likely
be less kind and gentle than a Fed managed unwind (which itself would not be
pain free).
Of course, we
will get some good feedback next week from the FOMC meeting. The pundits seem roughly divided on whether or
not the Fed will raise rates. However,
at the close yesterday, the bond market was pricing in a less than even chance
of a rate increase occurring.
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 know that I sounded
negative for the last eighteen months. The
primary reason being that more and more of our Portfolios’ holdings were
hitting their Sell Half prices. Secondarily,
our Market Valuation Model basically reflected the same thing; that is, a 2015 S&P
year end Fair Value of around 1525. So my
focus has been on gap between Market price and Fair Value and the triggers that
could cause mean reversion. The article
below reminds me that in arguing for mean reversion, I am not suggesting an
economic/Market calamity the proportion of 2008/2009. As I state below, ‘this is not a recommendation
to run for the hills’ but an admonition that you prepare your Portfolio for some
damage.
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 16433
1961
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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