The Closing Bell
1/30/16
Statistical
Summary
Current Economic Forecast
2015
estimates
Real
Growth in Gross Domestic Product (revised)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
2016 estimates
Real
Growth in Gross Domestic Product -1.0-+1.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -10-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Downtrend 16841-17588
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5471-19343
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Downtrend 1916-2007
Intermediate
Trading Range 1867-2134
Long Term Uptrend 800-2161
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. This
week’s dataflow continued in the negative: above estimates: the November Case
Shiller home price index, weekly mortgage and purchase applications, December
new home sales, weekly jobless claims, January Chicago PMI, January consumer sentiment;
below estimates: December pending home sales, January consumer confidence, the
Dallas, Kansas City and Richmond Feds’ January manufacturing indices, December
durable goods orders, month to date retail chain store sales, fourth quarter
GDP and the November trade deficit; in line with estimates: the January Market
flash services PMI.
The primary indicators
were also negative: December new home sales (+), December durable goods orders
(-) and fourth quarter GDP (-)---so more of the same dismal news.
The Fed provided
a small surprise: the narrative in the statement from the latest FOMC meeting
being less dovish that anticipated. I
found that somewhat encouraging, i.e. maintaining a focus on exiting QE. However, if we get another down leg in the
Market, I have little doubt that the Fed will chicken out in its effort to
normalize monetary policy.
In sum, the stats
this week was discouraging again,
keeping an overwhelmingly disappointing series of data intact (four mixed to
upbeat weeks and eighteen negative weeks in the last twenty-two). As I noted last week, a couple more weeks of poor
numbers, I will likely revise our forecast even lower with a strong probability
of recession.
The international
data was mixed; but the central banks were busy little beavers expanding QE. The Bank of China made three sizable
injections into its financial system; and the Bank of Japan, having poo pooed any
additional QE steps, announced negative interest rates---apparently once again following
the thesis that if an excessive dose of QE doesn’t work, then the best course
is to quadruple down. My guess is this
will lead to further competitive devaluations from China and the EU.
In summary, the US
economic stats this week were not good, the international data weren’t much
better and the central banks’ renewed love affair with QE will only make
matters worse.
Thoughts from an
economic optimist (medium):
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 the Treasury Department’s Office of
Financial Research warned of financial defaults among oil companies and the
banks that finance them.
That noted, I have shifted focus of late away from the US
banking system toward the rising risks overseas. The above clearly reminds us that all is not
well at home. But I stand by the thesis
that our financial system is much less at risk than it was seven years, five
years or even two years ago.
Meanwhile, the recent warnings from multiple countries
about troubles with their banks keeps the risks of potential bank
defaults/insolvencies and unstable currencies on the table.
Here is more detail on the solvency problems with Italian
banks (medium):
(2) fiscal/regulatory
policy. Not much news this week.
(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 central
banksters were hard at work this week. Top
officials from China, Japan and the ECB were all on their podiums extolling the
virtues of QE. China and Japan were
doing more than talking:
[a] China
injected substantial liquidity into its financial system three times
[b] in an
apparent attempt to provide the ultimate test of Einstein’s theory of insanity,
Japan instituted negative interest rates. My assumption is that this action will lead to
additional competitive devaluations from China and the EU. If that occurs, the questions become, where
does it end and how badly? So QE
continues apace irrespective of what our own Fed does. As a side note, it will also test my thesis that
the larger the magnitude and the longer QE lasts, the greater the ultimate pain
of unwinding it.
Speaking of the
Fed [and I wish I weren’t], Yellen et al whined about the economy and seemed to
crawfish on the March rate hike at this week’s FOMC meeting. As you know, I am not all that concerned that
the Fed’s suggested slow rate of piddling rate hikes will hamper economic
growth for the simple reason that since 2009 their aggressive rate cuts and
gargantuan liquidity injections did little to improve economic growth.
What I do worry
about is that any back peddling on monetary normalization by the Fed will put
it in the QEInfinity/competitive devaluation race to bottom camp with the rest
of the global financial wizards.
As I said
Thursday, the above doesn’t mean that the central bankers’ anxiety over
recession is unfounded. I worry about
that endlessly in these pages. My point
has been and remains, if a recession occurs it will be more a function of
results of an experimental, ill thought out, overly aggressive QE policy than
from a midget sized increase in the Fed Funds rate off a zero bound base.
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: nothing this week save the Iranians touring Europe and spending that
$150 billion cash bonus like drunken sailors.
The good news is that they aren’t buying bombs---at least that we know
about.
(5)
economic difficulties in Europe and around the globe. There was few international economic stats
released this week: UK fourth quarter GDP grew at the lowest rate in three
years; EU economic confidence was the lowest in five months. On the other hand, both France and Spain
posted better than expected 2015 GDP growth.
Clearly a mixed week, which in itself is a positive given the abysmal
flow of data from abroad for the last five to six months. Other
global economic news:
[a] the central banks {China, Japan and the ECB} continued
their headlong pursuit of QE,
[b] oil prices: which continue negatively impacting the global
economy via the slowdown of demand, the capital spending restraint and
liquidation of the sovereign wealth funds of the oil producing nations. This week, {i} IMF and World Bank officials
journeyed to Azerbaijan in an attempt to keep it from becoming the first
sovereign to default as a result of low oil prices and {ii} OPEC offered to ‘manage’
its production if non-OPEC would also comply.
Then there were rumors, subsequently squashed, that a meeting would
occur in February. At the moment, higher
oil prices are just a gleam in investors’ eyes.
In sum, the global economic outlook has
not improved.
Bottom line: the US data continues to reflect very sluggish
growth in the economy, perhaps in recession.
My hope that the rate of slowing may have stabilized is dwindling. Of course, the global economy is certainly
not doing anything to brighten the outlook.
Meanwhile, several of the major
global central banks have not backed off the QE policies even though to date
those policies have only made matters worse.
Unfortunately, that may not stop the Fed from reversing its policies if
the Markets continue to get pummeled.
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 were
up; December pending home sales were well below estimates; the November Case
Shiller home price index rose more than anticipated,
(2)
consumer: month to date retail chain store sales growth
was lower than the prior week; January consumer sentiment was better than
expected, but consumer confidence was worse,
(3)
industry: both the January Dallas and Richmond Fed
manufacturing indices fell precipitously, while the Kansas City Fed’s index was
flat; the January Markit flash services PMI was flat with December’s reading;
the January Chicago PMI was very upbeat,
(4)
macroeconomic: fourth quarter GDP was up less than
expected; the November US trade deficit was larger than estimated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16466, S&P 1940) did a moon shot on Friday, concluding another extremely
volatile week. The Dow closed [a] below
its 100 day moving average, now resistance, [b] below its 200 day moving
average, now resistance, [c] below the lower boundary of a short term downtrend
{16872-17620}, [c] in an intermediate term trading range {15842-18295}, [d] in
a long term uptrend {5471-19343}, [e] and still within a series of lower highs.
The S&P
finished [a] below its 100 day moving average, now resistance, [b] below its
200 day moving average, now resistance [c] within a short term downtrend {1916-2007},
[d] in an intermediate term trading range {1867-2134}, [e] in a long term
uptrend {800-2161} and [f] still within
a series of lower highs.
Volume spiked on
Friday; breadth continued to improve.
The VIX was down 10% but ended [a] above its 100 day moving average, now
support; however, the MA is declining, detracting from its strength as support
and [b] in short term, intermediate term and long term trading ranges.
The long
Treasury had another good week, closing up on Friday. It finished above its 100 day moving average,
now support and within short term and intermediate term trading ranges.
GLD rose,
remaining [a] above its 100 day moving average, now support but [b] within
short, intermediate and long term downtrends.
Must read
(medium):
Bottom line: the
Averages broke out of their recent high volatility trading range, providing the
first sign of follow through since making a low January 10th... The S&P busted through the 1928 Fibonacci
retracement level as well as closing above the lower boundary of its short term
downtrend. Unless the Averages do a
dramatic reversal Monday, I think it likely to see additional upside---that
could take the S&P to the upper boundary of its short term downtrend which
also happens to be very close to its 100 day moving average.
GLD is trying to
make a bottom. It has managed to revert
its 100 day moving average from resistance to support and is near the upper
boundaries of its short term and intermediate term downtrends. If those levels are successfully challenged, GLD
could again offer some opportunity.
Margin debt in
Chinese markets (medium):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16466)
finished this week about 33.5% above Fair Value (12333) while the S&P (1940)
closed 26.9% overvalued (1528). 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.
This week’s
economic data was disappointing. So the hope of an economy stabilizing at a
lower rate of growth is fading; and the risk of recession is on the increase. The global economy remains a mess, its banking
system increasingly infirm and the tensions in the Middle East raise the risk
of some untoward event igniting all-out war. The risk here is that many Street economic forecasts
are too optimistic (and they assume none of the above occurs); and if they are revised
down, it will likely be accompanied by lower Valuation estimates.
This week the
Fed disappointed the Markets when the statement from the FOMC meeting had a
less dovish tone than investors wanted.
I ranted enough about this in Thursday’s Morning Call and above. And the bottom line hasn’t changed: the
termination of QE will likely have little impact on the economy but will affect
the Markets negatively. The longer it
lasts and the larger the magnitude of QE, the greater the Market pain when it
is finally over or when the Markets finally figure out the shell game.
Meanwhile, most
of the other major central banks continue to aggressively pursue easy money
policies in the hope that if a lot of extra liquidity didn’t work, maybe a
whole lot of extra liquidity will. And
nothing says ‘a whole lot of extra liquidity’ like this week’s aggressive
Chinese liquidity injections and the stunning move by Japan to institute
negative interest rates.
Even more
discouraging, the linkage between QE and investor euphoria does not seem to
have been broken---witness the Markets’ negative response to the less dovish message
from the Fed and Friday’s Titan III shot on the Bank of Japan’s move to
negative interest rates.
I continue to
believe that this latest round of QE will be just as unsuccessful as all the
prior ones (QE1 excluded); but it will likely push asset mispricing and
misallocation to a new extreme. Sooner
or later, there will be Market pain.
Today’s must
read (medium):
Whenever that happens, I believe that the cash
generated by following our Price Discipline will be welcome when investors wake
up to the Fed’s (and other central bank) 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. As a secondary objective, I would reconsider
any thoughts of ‘buying the dip’.
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 2016 Year End Fair Value*
12700 1570
Fair Value as of 1/31/16 12333
1528
Close this week 16466
1940
Over Valuation vs. 1/31 Close
5% overvalued 12949 1604
10%
overvalued 13566 1680
15%
overvalued 14182 1757
20%
overvalued 14799 1833
25%
overvalued 15416 1910
30%
overvalued 16032 1986
35%
overvalued 16649 2062
Under Valuation vs. 1/31 Close
5%
undervalued 11716
1451
10%undervalued 11099 1375
15%undervalued 10483 1298
* 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.
