The Closing Bell
11/7/15
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)
-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 1950-2742
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 solidly positive. This is
the second time in three weeks that the data has been either a neutral or a
plus: above estimates: the October ISM
manufacturing and service indices, September construction spending, month to
date retail chain store sales, October light vehicle sales, the October ADP
private payroll report, October nonfarm payrolls, the September trade deficit, October
consumer credit, third quarter productivity and unit labor costs; below
estimates: September factory orders, weekly mortgage and purchase applications,
weekly jobless claims, October retail sales; in line with estimates: the
October manufacturing and services PMI’s.
Likewise, the
primary indicators were also upbeat: September construction spending (+), the
October ISM indices (++). October light vehicle sales (+), October nonfarm
payrolls (+) and September factory orders (-).
While these
numbers are unquestionably positive and while they represent the second time in
three weeks that the data has exhibited something other than a nose dive, it is
still too soon to conclude that the declining rate of growth has leveled
off. To be clear, even if it has, it
won’t change the fact that growth has decelerated; it may, however, take the
possibility of recession off the table. Whether
or not that is the case is now, to coin a phrase, ‘data dependent’.
Overseas, the data
flow remained lousy.
But once again,
the lead economic story of the week was the Fed:
(1) yet
another flip flop by the Fed on the timing of a rate hike. On Wednesday, Yellen reversed the prior Fed
dovish comments by declaring a December rate increase as a strong
probability. I don’t think that is any
commentary on the economy because for years Fed policy has never been about the
economy but rather the Market. So my
original thought was that in light of the latest Market moon shot, Yellen
decided to test out the ‘rate hike scenario’ for Market reaction. Calm acceptance would likely mean a December
rate hike; panic would mean another excuse to do nothing. But
then:
(2) this
was followed by a stunning comment from a Fed member [before the release of the
jobs report], basically saying that a weak nonfarm payroll number was not
really bad economic news---in other words, even if Friday’s employment was below
expectations, that wouldn’t take a December rate hike off the table. Of course, Friday’s payroll report smoked the
estimates, so those comments aren’t particularly relevant---unless, the Fed has
a rate hike planned irrespective of the economic numbers. In that case, it could put Yellen et al in an
uncomfortable position---what do they do if the data between now and December
rocks but the Market sinks? Answer:
weasel, again.
In summary, the US
economic stats may be showing signs of stabilizing 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. Good luck with that Janet.
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.
Odds
of a recession are rising (medium):
A
more optimistic view (medium):
Update on the big
four economic indicators:
The
negatives:
(1)
a vulnerable global banking system. There was a mix of news this week on the
health of global financial institution:
[a] Draghi
endorsed a measure to insure the safety of EU bank deposits,
[b] the
Financial Stability Board said major banks still have much to do to avoid the
need of a bail out (medium):
[c] one analyst said that China is sitting on a nonperforming
loan bomb (medium):
Which explains the lack of economic growth as a product of
debt expansion (short):
[d] unfortunately, in the US, student and auto loans are
soaring, potentially setting us up for a similar problem.
‘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. We have a new speaker of the
house that is making all kinds of promises of fiscal responsibility. On the other hand, he voted for the budget
measure that forfeited budget caps. Do
as I say…..
Meanwhile,
Obama DK’ed the XL Pipeline, proving once again that, in Washington, ideology
always trumps common sense [note: all that Canadian oil will still come to the
US, it will just do so in trucks and trains which cause more pollution than a
pipeline.]
(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.
QE worshipers
received a boost this week from the central bank of Australia [saying that
there was plenty of room for more QE there] and Draghi [who in a speech having
nothing to do with QE] anticipated more QE in December.
On the other
hand, Yellen in congressional testimony [and with support of Bill Dudley] put a
December rate hike squarely in the middle of the table. This was confirmed by a later statement from
another Fed member that lousy data doesn’t mean no rate hike. Talk about the schizophrenic nature of Fed
rate hike statements over the last year!
My conclusion
from all of this is that Yellen et al have decided to raise rates in December
so they are giving everyone a heads up. But
having put an interest rate increase in December on the table and then said
that it wasn’t data dependent, Ms. Yellen has a big problem if the stats stay
good but the Market doesn’t. It will be
interesting to see how the Fed reacts if that scenario were to develop.
My thesis has
changed slightly:
[a] QE {except
QEI} has had a negative impact on the economy; so unwinding it will have a
positive 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 I am correct
about 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 in a desperate
attempt to extricate itself from the problem, it may make another equally
disastrous misjudgment and only make matters worse.
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.
From Bill Gross (medium):
The Fed’s grand delusion
(medium):
(4) geopolitical
risks: talk about a clusterf**k. The
situation in Syria is getting more complicated: [a] US is sending ‘advisors’
into Syria [b] to assist Kurdish rebels which are considered terrorists by NATO
ally, Turkey, [c] while Russia builds its naval presence in eastern Mediterranean.
And it just
keeps getting worse (medium):
I am not worried about who is killing who in
this war. As far as I am concerned, the
US is a net winner in any case. However,
the more players and the more pervasive their presence, the greater the odds of
an ‘accidental’ confrontation that could lead to something much bigger.
I am also
uneasy about the continuing erosion of respect accorded to the US. Weakness is not a quality admired by our
major adversaries and could lead them to pursue even more aggressive anti-US
policies.
Given the
cluelessness of our current foreign policy, the risks exist of either [a]
further humiliation which will be difficult for the next administration to walk
back or [b] an inappropriate US response in an attempt to prove it has
cojones. While I have no idea about the
odds of either transpiring, they are not zero and that makes me a bit nervous.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. This week’s overseas economic
stats included: disappointing October
Chinese manufacturing and services indices, leading to a negative composite
PMI; better than expected manufacturing EU PMI but a lower than estimated
services PMI; terrible German factory orders and poor industrial output; a
decline in October EU retail sales; and slightly improved UK manufacturing and
services PMI’s. In sum, the international
dataflow remains negative.
Add to it this
bit of lousy anecdotal news (medium):
There is some good
news, to wit, at least in Europe, officialdom is attempting to address the
issue of bank solvency. The bad news is
that those poor economic numbers encourage the aggressive pursuit of QE,
however ineffective it has been to date.
Finally, there
is one big unknown lurking out there; and that is the state of the Chinese
financial system. To be sure, the
Chinese only report what they want to report and much of that is lies. But enough non-Chinese China analysts believe
that there are massive amounts of nonperforming assets on Chinese bank balance
sheets [see link above]---perhaps sufficient to rival the Lehman Brothers, Bear
Stearns, AIG debacle. That being said
[a] no one really knows and [b] the Chinese government has more resources to
deal with a similar situation were it to occur than the US did. So, the point here is merely to point out a
potential problem and the necessity of watching closely for confirming/nonconfirming
evidence.
In sum, the
international economic news was lousy, so the monetary spigots will likely be
opened wider---enabling the central bankers to push the misallocation and
pricing of assets to its logical conclusion.
This combo keeps the yellow flashing on our global ‘muddling through’ assumption;
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. In addition, 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 while I may have to do so again, the data
from the last three weeks provides the hope that I may not and that recession
is off the table.
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: weekly mortgage and purchase applications fell,
(2)
consumer: month to date retail chain store sales improved
from the prior week but October retail sales were weak; October light vehicle
were better than anticipated; the October ADP private payroll report was better
than estimates; October nonfarm payrolls were well ahead of consensus; weekly
jobless claims were below forecast, growth in consumer credit was very strong,
(3)
industry: the October services PMI was flat with
September; October ISM manufacturing index was slightly ahead of expectations;
September factory orders were a disappointment,
(4)
macroeconomic: the September trade deficit was less
than consensus; third quarter nonfarm productivity and unit labor costs were
much better than projected.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17910, S&P 2099) slowed their meteoric advance late in the week as
the rising probability of a December rate hike began to sink in. The Dow ended [a] below its 100 and 200 day
moving averages, both of which represent resistance, [b] in 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] below its 100 and 200 day moving averages, both of which represent
resistance, [b] in a short term trading range {2016-2104}, [d] in an
intermediate term uptrend {1950-2742} [e] a long term uptrend {800-2161}.
Volume increased
slightly; breadth was mixed. The VIX (14.3)
was off 5%, finishing [a] below its 100 day moving average, now resistance, [b]
within a short term downtrend and [c] in intermediate term and long term
trading ranges. A return to the 12-13
zone would again represent an opportunity to buy cheap portfolio insurance.
The long
Treasury got whacked, ending [a] below its 100 day moving average, still
support; but if it trades there through the close on Tuesday, it will revert to
resistance, and (2) below the lower boundary of the developing pennant
formation; this violation points to more downside in bond prices. Just as important, not only did the long
Treasury take it in the snoot, bond prices across all spectrums were down
sharply. Clearly, bond investors are
finally getting serious about a December rate hike, presumably a result of the
Friday jobs report and/or the Yellen/Bullock comments.
GLD also got
hammered, closing [a] below its 100 day moving average, now resistance, [b] in
a short term trading range, [c] in intermediate and long term downtrends. GLD remains a disappointment.
Bottom line:
stocks closed at elevated levels on Friday, though in a minor pause likely the
result of not only some consolidation after being overbought but also investor hesitation
as the odds of a December rate hike increase.
To be sure, the Market did not act with the same violence as it did on
prior occasions when higher rates were threatened.
So it seems to
me that the Market still has some upside. Any further advance would not only set
up a challenge of the Averages all-time highs and the upper boundaries of their
long term uptrends but will also be a major test of my thesis that rising rates
will have a negative impact on stock prices.
If we do get
those challenges of the all-time highs and long term uptrends, I don’t think
that those challenges will be successful---which, if followed by a rollover in
the Market could end up supporting my thesis.
In the meantime, I am drawing near to being proved right or wrong
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17910)
finished this week about 46.0% above Fair Value (12267) while the S&P (2099)
closed 38.0% 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 US economic
data may be stabilizing, signifying a leveling out at a lower rate of
growth. We can’t conclude that yet
because it is too soon. But it is
hopefully a sign that a recession is not in the offing. That said, the global economy is giving no
signs of strengthening. That in turn
makes it all the more difficult for the US to continue to grow.
In sum, the US economy
may have hit a new lower rate of growth while global economy remains weak. 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
made hawkish comments leading many to believe that a December rate hike is back
on the table. Confused? So is the Fed. Unfortunately, whatever it does at this point
is probably meaningless. The cold, hard facts, as I see them, are that the Fed
(1) has pursued a policy that has created another asset bubble, (2) it has
waited too long to attempt to correct that mistake, and (3) its only choices
are to do the right thing [i.e. return to a normalized monetary policy], which
will be painful, or to continue to pursue a disastrous strategy hoping and
praying for a miraculous way out, which I believe will end even more painfully when
hope and prayer prove an empty strategy.
That said, I
have no idea at what point investors figure out this no win equation. However, whenever and whatever happens, I believe
that the cash generated by following our Price Discipline will be welcome when
investors wake up because I suspect the results will not be pretty.
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 they 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; a potential escalation of
violence in the Middle East) 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 17910
2099
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.
No comments:
Post a Comment