11/21/15
Family begins to arrive on
Tuesday for Thanksgiving. No Morning
Calls or Closing Bell next week. Have a
great holiday.
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)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 16919-18148
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5471-19343
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2016-2104
Intermediate
Term Uptrend 1963-2756
Long Term Uptrend 800-2161
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
2016
Year End Fair Value 1560-1580
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 mixed quantitatively but negative qualitatively: above estimates:
weekly mortgage and purchase applications, month to date retail chain store
sales, the Kansas City and Philly Fed indices and October leading economic
indicators; below estimates: the NY Fed manufacturing index, October industrial
production, the November housing index, October housing starts and building permits;
in line with estimates: weekly jobless claims and October CPI.
The primary
indicators were negative: housing starts [-], industrial production [-] and the
leading economic indicators [+]. In addition,
(1) with 90% of the S&P companies reporting, aggregate earnings are down
2.4% and (2) the anecdotal evidence was weak: base metals’ prices continue to
crash, the Baltic Dry Index is at all-time lows, and imports at the three
largest US ports fell in September and October.
Is the commodity
decline over? (medium):
In sum, the data
remains disappointing, provides scant evidence that the economy is not losing
strength and can in no way be interpreted as ‘improving’ (sorry, Janet).
Still, we can’t
ignore the recent two weeks of better numbers; that keeps me hopeful the slide
in economic activity has stabilized and the threat of recession lessened. However,
two good weeks out of twelve is a pretty thin reed on which to hang those hopes.
For the moment, I am sticking with our
current forecast; but if the last two weeks are a sign of further weakness to
come, then this can only go on for so long before recession has to be
considered a decent probability.
Weighing on our
economic prospects is the continuing stream of poor data from abroad---the data
this week was virtually all bad. In
addition, if the Middle East war has expanded geographically, it will likely serve
as an additional burden on the global economy.
The Fed was back
in the spotlight this week with the release of the minutes from its latest FOMC
meeting. They reiterated that the odds
of a December rate hike were high---based on the improving US and global
economies. I have already commented on
the idiocy of this statement. Anyone who
can read and listen knows that is not the case.
Of course,
anyone who can read and listen knows that the Fed cares a great deal more about
the Markets than it does about the economy.
And based on the free pass the Markets are giving the Fed to date, I don’t
know how a December rate hike is not a lock. The problem is how this plays out
if the economy continues to deteriorate and if the ECB institutes another round
of QE easing (which also appears a lock at this time)---which further strengthens
the dollar, hurting US foreign earnings and sales even more. Probably not well; but then that has been the
history of Fed policy transitions since the beginning of time. So why should anything be different this
time?
In summary, the US
economic stats may to be fading again while the international data remains sub-par. In the meantime, the Fed is praying the
Market holds in the face of a more likely December rate hike so it can make at
least a token move toward monetary normalization.
Our forecast:
a much below average secular rate of
recovery, exacerbated by a declining cyclical pattern of growth with an
increasing chance of a recession 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
negatives:
(1)
a vulnerable global banking system. This week:
[a] Barclay’s was fined additional monies for fraud in
foreign currency trading.
[b] the ECB said that nine large EU banks have a cumulative
capital shortfall of $1.9 billion.
The multi trillion dollar liquidity problem (medium):
The multi trillion dollar currency problem (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. This week the US Treasury
announced it has instituted a new set of rules to counter ‘tax inversion’ deals
[companies moving off shore to avoid US taxes].
Which begs the question, why not lower taxes so there is no incentive to
move? But that would be too simple for a
progressive regime.
Read this on
the cost of regulations for small businesses (medium):
(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
released the minutes from its latest FOMC meeting on Wednesday; and they read
pretty much like the statement issued following the meeting, i.e. it is on
track to raise rates in December. Driving
the decision, they say, is that everything is just hunky dory in both the US
and global economies---which, as I noted above, is pure hogwash.
The result of
this fantasy is that the Fed would be raising rates [and strengthening the
dollar] in the midst of a further weakening in US economic activity and right
before a lowering of rates in Europe [strengthening the dollar even
more]---which probably won’t do much for all the optimists looking for an
upbeat 2016.
My thesis is:
[a] QE {except
QEI} has had a long term negative impact on the economy; so unwinding it will
have a positive long term 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. Indeed, if they go through
with the December rate hike, it will be raising rates in the midst of a
slowdown in economic growth,
[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 {i} in a desperate
attempt to extricate itself from the problem, it may make another equally
disastrous misjudgment and only make matters worse, {ii} and/or the ECB lowers
rate. Speaking of which, on Thursday, we
got yet another reminder from Draghi that more EU QE is on the way. Unfortunately, that only aggravates the tendency
towards further strengthening of the dollar, which makes the US economy weaker,
which……. you get the point.
What happens to
corporate profits when the dollar strengthens (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.
This is a
little deep in the weeds, but it is an excellent analysis of the Fed’s current
problem (long):
Fed to hold expedited, closed
meeting on Monday (short):
(4) geopolitical
risks: after the Paris tragedy, the question is, is the war now expanding
geographically? I am not sure ISIS has
the manpower and resources to sustain a campaign of terror in the West. But the actions in Belgium and Mali belie
that. Still the ability to maintain long
term operations remains to be seen. If
it can, then that will almost certainly have a negative impact at least on the
EU economy---lower tourism, reduced recreational activity, more resources
devoted to security.
More on the economic
impact of the Paris attack (medium):
***overnight,
new problems in Brussels (medium):
However, the
longer term is more critical; that is, has the West finally had enough of the
politically correct notion that Islamic terrorism is a criminal activity rather
than a war of cultures? That also
remains to be seen; but if political correctness wins out, better start looking
for a home in Costa Rica.
The danger in
thinking Saudi Arabia is our friend and ally (medium and a must read):
(5) economic
difficulties in Europe and around the globe. This week’s overseas economic stats continued
an awful string of releases: Japanese
third quarter GDP fell and the second quarter figure was revised down; plus its
October imports and exports were disastrous numbers; October UK inflation was down
and its factory output was also down.
All this made worse by the potential for an expanded Middle East war.
We did get one
piece of good news: the Greek parliament approved reform measures that will
smooth the way to more bail out money.
Truth telling
on the Chinese economy (medium):
Japan joins
China and the US in making up the numbers to fit desired narrative (medium and
a must read):
As a result, this
keeps the yellow flashing on our global ‘muddling through’ assumption; but a
flashing red light is not that far away.
Bottom line: the US data continues to reflect very sluggish
growth in the economy, though its rate of slowing may have stabilized. However, global economic trends are still
deteriorating; and the Fed, paralyzed by fear of the consequences of prior
policy mistakes, has potentially put itself in an untenable position.
As you know, I recently
lowered our economic forecast for a second time. And I may have to do so again.
A deteriorating
global economy and a counterproductive central bank monetary policy are the biggest
economic risks to our forecast.
This week’s
data:
(1)
housing: October housing starts were down much more
than anticipated; weekly mortgage and purchase applications rose; the November
NAHB index was below estimates,
(2)
consumer: month to date retail chain store sales were
up slightly; weekly jobless claims were down slightly less than forecast,
(3)
industry: October industrial production was very
disappointing; the November NY Fed manufacturing index was below expectations,
while the Kansas City and Philly Fed index were above,
(4)
macroeconomic: October CPI was in line; October leading
economic indicators were above projections.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17823, S&P 2089) managed to follow through to the upside on Friday. The Dow ended [a] above its 100 moving
average, which represents support, [b] above its 200 day moving average, now
support, [c] within a short term trading range {16919-18148}, [c] in an intermediate
term trading range {15842-18295} and [d] in a long term uptrend {5471-19343}.
The S&P
finished [a] above its 100 moving average, which represents support, [b] above
its 200 day moving average, now support, [c] in a short term trading range
{2016-2104}, [d] in an intermediate term uptrend {1963-2756} [e] a long term
uptrend {800-2161}.
Volume rose, but
that was influenced by option expiration; breadth improved. The VIX (15.5) was down 9%, ending [a] below its
100 day moving average, now resistance, [b] in a short term downtrend and [c]
in intermediate term and long term trading ranges.
The long
Treasury fell, retreating from its 100 day moving average, which it touched on
Thursday and within very short term, short term and intermediate term trading
ranges.
GLD was down,
ending [a] below its 100 day moving average, now resistance and [b] within
short, intermediate and long term downtrends.
Bottom line: the
bulls held the field this week overcoming many of the potential breaks of
support that were occurring at the end of last week. In addition, their very short term downtrends
were negated and, at least as of the close Friday, had managed to avoid making
lower highs.
As I noted
several times this week, it appears that the historically strong seasonal
upward bias is kicking, seemingly oblivious to the poor economic data, the
potential negative economic consequences of an expanding war on terror within the
EU and the increased likelihood of a higher Fed Funds rate (and with it a
stronger dollar and weaker corporate profits). I can only assume that this positive bias
will be with us through the New Year, which cranks up the odds in the interim of
challenges to the indices all-time highs and upper boundaries of their long
term uptrends. But as you know, I don’t
believe that those challenges will be successful.
Did the Santa
Claus rally start this week? (short):
More data on the
seasonal bias (short):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17823)
finished this week about 45.3% above Fair Value (12267) while the S&P (2089)
closed 37.3% overvalued (1521). 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 recent trend
towards more stable economic numbers took a blow this week. I am not giving up just yet that conditions
could be leveling out; but two upbeat weeks in the last five (12) is not a lot
to hang that hope on. Further poor
aggregate data will push the risk of recession back to the forefront. At the moment, it remains too soon to know.
Unfortunately,
the global economy remains a mess and it’s not being helped by growing political
turmoil in Europe---and that in turn makes it all the more difficult for the US
to continue to grow.
In sum, the US economic
picture is a bit muddy at the moment; although, not so much so that we can’t
conclude that it is weaker than it was three months ago. In the meantime, the global economy is not
the least bit murky---it is crappy, getting worse and will likely be exacerbated
by recent terrorists’ attacks. The risk here is that many Street forecasts are
too optimistic; and if they are revised down, it will likely be accompanied by
lower Valuation estimates.
This week, the Fed
minutes reaffirmed the hawkish comments in the statement released after the
last FOMC meeting, raising the odds of a December rate hike. I am a bit confused by what this could mean
for stocks because on Monday, stocks roared on the notion that the Paris attack
made a rate hike less probable; then smoked again of Friday after the release
of the aforementioned hawkish FOMC minutes.
As you know, I believe that a return to normalized monetary policy will
be bad for stocks, though I am not sure how fast that becomes manifest if the
Fed does a one and done or something akin to it. Nonetheless, I stand by the forecast; and the
good news is that we are apt to know if I am right or wrong in the next couple
of months---assuming that rates go up in December.
However, whenever and whatever happens, I believe
that the cash generated by following our Price Discipline will be welcome when
investors wake up to the Fed’s malfeasance because I suspect the results will
not be pretty.
Net, net, my two
biggest concerns for the Markets are (1) declining profit and valuation
estimates resulting from the economic effects of a slowing global economy and
(2) the unwinding of the gross mispricing and misallocation of assets following
the Fed’s wildly unsuccessful, experimental QE policy.
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 own 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; a potential escalation of
violence in the Middle East and around the world) 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 11/30/15 12267
1521
Close this week 17823
2089
Over Valuation vs. 11/30 Close
5% overvalued 12880 1597
10%
overvalued 13493 1673
15%
overvalued 14107 1749
20%
overvalued 14720 1825
25%
overvalued 15333 1901
30%
overvalued 15947 1977
35%
overvalued 16550 2053
40%
overvalued 17173 2129
45%
overvalued 17787 2205
50%
overvalued 18400 2281
Under Valuation vs. 11/30 Close
5%
undervalued 11653
1444
10%undervalued 11040 1368
15%undervalued 10426 1292
* 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.
