The Closing Bell
1/9/16
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 Trading Range 16919-18148
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 Trading Range 2016-2104
Intermediate
Term Uptrend 1975-2768
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. The dataflow
this week was lousy: above estimates: month to date retail chain store sales,
the ADP private payroll report, December nonfarm payrolls, the November trade
deficit; below estimates: weekly mortgage and purchase applications, December
light vehicle sales, both the PMI manufacturing and nonmanufacturing indices,
November construction spending, both December ISM manufacturing and nonmanufacturing
indices, December wholesale inventories and sales, weekly jobless claims; in
line with estimates: November factory orders.
The primary
indicators were also poor: December nonfarm payrolls (+), construction spending
[-], December ISM manufacturing and nonmanufacturing indices [- -]. To be sure the December payroll number is a
plus---who can argue with more people working?
But don’t forget, employment is a lagging indicator. However, especially
concerning is the ISM nonmanufacturing index because (1) the economic bulls’
standard argument against the dangers of a recession has been that the despite
poor manufacturing data, the services indices have been positive, (2) it was
reinforced by the PMI services index and (3) it was the second monthly decline
in a row. Oooops.
In sum, the data
this week clearly did not help the thesis that the economy has found a new
level of slower growth (four mixed to upbeat weeks and fifteen negative weeks
in the last nineteen). Still, we can’t
ignore those four weeks of mixed to better numbers; that keeps me hopeful that the
slide in economic activity has stabilized and the threat of recession lessened. For the moment, I am sticking with our recently
revised forecast of slowing growth---which is reflected in our 2016 economic
forecast posted above. Nevertheless, the
risk of recession remains above average.
On the other
hand, Europe provided upbeat economic stats this week which, at least, avoids
‘piling on’ our own abysmal data. This
is actually the second upbeat week in the last four. Of course, two weeks out of the last four
hardly defines a trend. In addition,
these better numbers were almost all ‘confidence’ readings while the actual
data were negative. Still perhaps, just
perhaps, these stats could be reinforcing the notion that both Europe and the
US have found a new lower level of economic growth.
Unfortunately,
China is not doing us or the rest of the world any favors. The yuan has been falling dramatically and
that likely means that the Chinese economy is not doing as well as they have
been reporting. Equally unfortunate,
since they have already been lying, the rest of the world will remain in the
dark and no one is going to know when, as and if the s**t hits the fan until
after the fact.
Finally, the Fed
released the latest FOMC minutes which reflected a less than enthusiastic
embrace of the recent rate hike and provided no guidance for any future
increases. That said, the dirty deed is
done; and any reversal now would simply confirm what I have been alleging for
longer than I can remember, i.e. the Fed is more worried about the Market than
the economy. Of course, the Market is
crashing; so barring a dramatic reversal, we are going to soon find out how
long the Fed is willing to keep up its current charade---especially since
Richard Fisher blew its cover this week.
That would clearly not inspire confidence; though why there was ever
confidence is a mystery to me.
In summary, the US
economic stats this week were awful; and while the numbers out of Europe provided
a tiny amount of solace, the sinking yuan raises concerns that the Chinese have
indeed been fabricating economic data better than reality. In the meantime with the US Markets are getting
hammered, I am sure the Fed is on its knees praying the Market holds.
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.
Update on big
four economic indicators:
The
negatives:
(1)
a vulnerable global banking system. This week, there was speculation that the
recent aggressive easing by the Chinese central bank as well as its yuan
devaluation was not just a function of poor economic performance but also
increasing nonperforming assets on bank balance sheets
In addition, there were also reports of US banks reducing
credit facilities to a number of fracking companies, suggesting that they are
worried about the loans they already have outstanding. But to reiterate a point that I have made
before, I believe that the US banking system’s solvency has dramatically
improved over the past couple of years primarily the result of regulatory actions as
well as the imposition of more stringent
‘stress tests’ by the Fed to avoid the bail out another ‘too big to
fail’ bank.
The death of another financial gimmick that bolstered bank
earnings (medium):
That said, if the warnings from multiple sources regarding
the deterioration of China’s financial system are anywhere near correct, the
risks to the global banking system still exist.
Our banks may be better able to withstand any fallout; but that doesn’t
mean others will. Hence, the risks
remain.
(2) fiscal/regulatory
policy. The good news is that congress
has been on vacation, so little legislative mischief has occurred in the past
weeks. The bad news is that Obama
continues to legislate by executive order.
This week it was gun control [a moment of silence for the teary
eyed]. While there are limits to the
impact He can have on this issue, what bothers me is what happens next. There simply is no telling what this Guy will
do in the next twelve months in the name of His legacy. If only someone had the balls to challenge
this usurpation of authority in the courts.
(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.
Two Fed related
news events this week:
[a] the minutes
from the last FOMC meeting were released and [a] the governors {somewhat reluctantly}
concluded that all was well with the economy {I still can’t figure out what
planet they are on} and [b] there was no added information to provide guidance
on speed or magnitude of future rate hikes---which in all likelihood won’t
occur anyway if the economic stats {and the Market} continue to
deteriorate. That said, since employment
is a favored datapoint with the Fed, the December nonfarm payrolls number will
likely give it the statistical cover to justify their recent move toward
tightening---which as you know, I applaud.
Unfortunately, if I am correct about the true Fed focus and the Market continues
to plunge, it will likely put a halt to further rate rises.
[b] former
Dallas Fed chief Fisher lifted the curtain on the Fed’s motivation for
QEInfinity, to wit, enhancing asset valuations---not a weak economy. He also noted that those very same assets
were now generously valued---not exactly a surprise.
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: the Middle East conflict is only getting worse. This week the Sunni/Shi’a schism broke into open
hostilities as the Saudis executed a Shi’a cleric, Iranians stormed a Saudi
embassy and diplomatic relations were terminated. Then on Thursday the Iranians accused the
Saudis of bombing their embassy in Yemen.
This is all that an already explosive mix needs. Now we have two area
nations fighting, two religious sects fighting and two world superpowers with
presence in the region that is a snakes’ nest of radical hotheads. What could possibly go wrong?
In addition,
the North Koreans announced that they had successfully tested a hydrogen
bomb. I don’t think that this is that
big a deal; certainly not rising to the level of distress voiced by the main
stream media. It bears little analysis
beyond my comments on Thursday:
‘Number one, these clowns lie habitually; so
we can’t be sure that this is even the case.
Number two, they generally don’t act without the approval of the Chinese
and I can think of no reason for the Chinese to want to start a nuclear
war. Number three, all that the North
Koreans have really done is replace one kind of nuclear device with a more
technologically advanced one. Finally,
if you are going to worry about some nut job detonating a nuclear device, worry
about radical Islam.’
(5)
economic difficulties in Europe and around the globe. This week saw some positive data: EU economic
confidence, business climate index, industrial confidence and unemployment
though retail sales were less than anticipated as was German industrial
production. Notice that most of the
upbeat numbers were ‘confidence’ related while most of the negatives measured
actual economic performance. Still these
stats are better than a sharp stick in the eye and offer some hope that the
rest of the world is not sinking into recession. The operative word being ‘hope’ since a
couple of ‘confidence’ datapoints is hardly a sign of stabilization,
China, on the
other hand, reported negative December manufacturing growth. Given its almost immediate devaluation of the
yuan, that likely is a telltale sign that all is not well in the Middle
Kingdom---in short, all their happy talk about their economy is likely just
that. As I noted above, the problem is
made all the more acute by the fact that they lie about their data; so we are
not going to know how bad things are until after the fact.
Finally, the
World Bank lowered its 2016 growth assumptions this week. While I never put much stock in that
institution’s forecast, it is mainly because they are too optimistic---which
clearly is not a good sign.
In sum, global economic stats were mixed
at best.
Bottom line: the US data continues to reflect very sluggish
growth in the economy, perhaps in recession; though my hope is that the rate of
slowing may have stabilized. However, global
economic trends are still deteriorating.
We are going to need a lot more than two weeks of upbeat Eurozone ‘confidence’
data to question that notion. Meanwhile,
given the recent Market pin action, the Fed is likely paralyzed by fear of the
consequences of prior policy mistakes and the probability that it has potentially
put itself in an untenable position.
A deteriorating
global economy and a counterproductive central bank monetary policy are the biggest
economic risks to our forecast.
Another
year of slow global economic growth (medium):
However,
none of this means that we are facing disaster (medium):
Interview
with Raoul Pal (medium):
This week’s
data:
(1)
housing: weekly mortgage applications were down but
purchase applications were absolutely terrible,
(2)
consumer: month to date retail chain store sales were strong
versus the prior week; December light vehicle sales were below estimates; the
ADP private payroll report was very upbeat as was the December nonfarm payrolls
report but weekly jobless claims fell more than anticipated,
(3)
industry: both December PMI manufacturing and services
indices were disappointing; November construction spending was well below
expectations; December wholesale inventories and sales were dismal; both
December ISM manufacturing and nonmanufacturing indices were below forecast;
November factory orders were in line,
(4)
macroeconomic: the November US trade deficit was slightly
lower than projections.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16346, S&P 1922) had a very rough week. The Dow ended [a] below its 100 moving
average, which now reverts to resistance, [b] below its 200 day moving average,
now resistance, [c] within a newly reset short term downtrend {17685-16942},
[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 moving average, which now reverts to resistance, [b]
below its 200 day moving average, now resistance [c] in a newly reset short
term downtrend {1949-2039}, [d] below the lower boundary of an intermediate term
uptrend {2000-2990} for the third day; if it remains there through the close
Monday, it will reset to a trading range, [e] a long term uptrend {800-2161}
and [f] still within a series of lower highs.
The average
stock is already in a bear market (medium):
Volume declined;
breadth was negative. The VIX was up 5%,
ending [a] above its 100 day moving average, which now reverts to support, [b] in
a short term, intermediate term and long term trading ranges.
The long
Treasury was up, closing above its 100 day moving average, which now reverts to
support and within very short term, short term and intermediate term trading
ranges.
GLD struggled to
maintain its recent advance but still ended [a] below its 100 day moving
average, now resistance and [b] within short, intermediate and long term downtrends.
Bottom line: the
Averages took out multiple support levels this week and Monday could witness
yet another. While stocks are very oversold, it looks to me like the Averages
will still probably test the 15840/1867 levels.
Primarily because they are simply reflecting what has already happened
in the broad market of stocks which now on average 20% off their highs. In fact, if the Averages only fall the same
as the broad market, they have another 10% to the downside. So declining to 15840/1867 is a hiccup.
The big
questions are, do price declines stop at 20% or do they match the 2008/2009
decline (~40%) or do they match historical mean reversions (~50%). Those questions are best left till
later. Near term, we must deal with
whether or not the Averages can hold 15840/1867; and if not, what are the next
visible support levels (14256/1576).
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16346)
finished this week about 32.5% above Fair Value (12333) while the S&P (1922)
closed 25.7% 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.
The recent trend
towards more stable economic numbers has been erratic at best. On the other hand, the string of positive
data weeks have all come in the recent past, keeping alive the hope that the
worst is over. So I am not giving up on
the notion just yet that conditions could be leveling out; but four mixed to upbeat
weeks in the last nineteen is not a lot to hang that hope on.
In addition, the
global economy remains a mess, this week’s better ‘confidence’ data from the
Eurozone notwithstanding. The main
source of this week’s heartburn is China as its manufacturing number turned
negative and the yuan was allowed to fall---which likely reflects the need for
a competitive devaluation to help stabilize its economy. Finally, the
heightened risk posed by the Saudi/Iranian cat fight adds yet another explosive
element to already primed tinderbox. Meanwhile, the North Korean claim of
successfully testing a hydrogen nuke also creates more uncertainty.
In sum, the US economic
picture remains murky at the moment; although, not so much so that we can’t
conclude that it is now weaker than it was three months ago. In the meantime, the global economy is lousy,
the escalation of tension in the Middle East raises the risk of some untoward
event igniting all-out war and the Chinese aggressive devaluation of the yuan
suggest additional problems in the global economy. The risk here is that many
Street economic forecasts are too optimistic; and if they are revised down, it
will likely be accompanied by lower Valuation estimates.
This week, (1)
Richard Fisher admitted that Fed policy was directed more at Market valuation
than economic improvement and (2) the FOMC minutes showed the Fed a bit more circumspect
about its recent rate hike. True the
most recent narrative via Fed member speeches support that move and December’s
nonfarm payroll number will help their dreamweaver rationalizations. But the
basis for their optimism is ignoring the economic environment around them and
any reversal of the rate hike now will likely destroy what little credibility
they have left after Fisher’s mea culpa.
Meanwhile the
Bank of China doesn’t appear to be leaving anything to the imagination of
investors. Its aggressive devaluation of
the yuan is telling the rest of the world that its economy needs help. Coupled with the Japanese nonstop liquidity
injections and Draghi’s recent reiteration of the ECB’s ‘whatever is necessary’
strategy, it sets up an interesting dichotomy between the rest of globe’s
central banks that are openly fighting recessionary forces and our own Fed that
is ignoring them.
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. 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.
Doug
Kass: Sell (medium):
Stocks priced for
perfection (medium):
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 1/31/16 12333
1528
Close this week 16346 1922
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
40%
overvalued 17266 2139
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.
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