The Closing Bell
1/16/16
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 16903-17665
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 1938-2028
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 was lousy: above estimates: weekly mortgage and purchase
applications, the December small business optimism index, January consumer
sentiment and the December budget deficit; below estimates: December retail
sales, month to date retail chain store sales, December industrial production,
the January NY Fed manufacturing index, weekly jobless claims, November
business inventories, December PPI, December import and export prices and the
Atlanta Fed year over year GDP growth estimate (which it lowered for a second
time to 0.6% Friday after the close); in line with estimates: November factory
orders.
The primary
indicators were also poor: December industrial production (-) and December
retail sales (-); and there were a couple of anecdotal stats: the Baltic Dry
index is falling off the chart and the latest Fed Beige Book portrayed an
improving economy across all geographic areas.
The latter clearly supports the Fed official narrative. However, I continue to ask what numbers these
guys are looking at (see above). But
then in the case of the Beige Book, it summarizes anecdotal evidence, so its
interpretation is more questionable than say---the Atlanta Fed GDP projection.
That said, the
official Fed narrative may be changing.
Witness the somewhat dovish comments this week from St. Louis Fed head
Bullard. I covered this in detail in Friday’s
Morning Call; but the bottom line is (1) the Fed has apparently woken up to the
fact that it can no longer pretend the economy is just hunky dory, (2) it is
alarmed that the Market [its true measure of monetary policy] is dropping like
a rock and (3) the only question is, at what point does the Market cease to pay
any attention to these clowns?
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 sixteen negative weeks
in the last twenty). Still, we can’t
ignore those four weeks of mixed to better numbers; although this week’s numbers,
especially industrial production and retail sales, make it a lot easier. For the moment, I am sticking with our recently
revised forecast of slowing growth.
Nevertheless, the risk of recession remains above average and rising.
The international
data returned to its disappointing way after a brief respite last week. Lousy stats came in from across globe: UK,
Japan and China. Especially worrisome is the Chinese government’s seemingly
loss of control over its economy/markets/yuan (more later). So the poor
overseas data continues to be a headwind to any improvement in the US economy.
In summary, the US
economic stats this week were awful; and the international numbers weren’t much
better. In the meantime with the US Markets are getting hammered, the Fed is on
likely its collective 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, the news was out of:
[a] Portugal where one bank is already insolvent and others
are expected to follow. Of course, on
the surface, Portugal is a wart on a goat’s ass; so why should we care? The answer is that it is victim of the same
economic imbalances as Greece and other southern EU countries. The risk being that this could develop into more
than isolated incident.
[b] the Bank of Oklahoma which told its shareholders that
it had incurred a larger than expected loss on a single loan to a company in
the oil patch. You can decide if you
think this a one-time occurrence or a sign of things to come; I lean to the
latter.
(2) fiscal/regulatory
policy. The good news is that there has
been little news out of congress. The
bad news is that in His state of the union message, Obama, in addition to the
monumentally egregious stretching of the facts and the constant self-congratulatory
high fives [I recognize full well that all presidents are guilty of this; Obama
has taken it to new heights], outlined a series of objectives that He will undoubtedly
utilize executive orders to implement if He can’t get congressional approval
which He undoubtedly won’t.
As I said last
week: ‘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.
Our Fed just
can’t learn its lesson. This week St.
Louis Fed head Bullard observed that low oil prices were negatively affecting the
Fed’s inflation forecast [remember 2% inflation is one of the primary
objectives of the Fed narrative]---like it didn’t know this a month ago when it
raised rates. As always these comments
were probably spawned not by oil [the economy] but by the recent decline in
stock prices. And as always [except QE1]
even if the Fed does adopted an easier stance in the name of inflation [plunging
oil prices] being too low, it will likely have no impact on inflation [oil
prices] ---because its policies have done nothing to lift inflation toward its
target for the past seven years. In
fact, what they have done has served to lower inflation [oil prices] by stimulating
supply via keeping borrowing costs low
and plenty money available for drilling.
I still have no
confidence in the Fed’s economic narrative and believe that [a] they are
largely focused on asset prices, [b] this has led to major distortions in asset
pricing and [c] sooner or later there will be hell to pay.
Thoughts
from a Fed optimist (short):
Counterpoint: (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.
(4) geopolitical
risks: the global jihadist war picked up some steam this week with attacks in both
Turkey and Indonesia. Further, it was
revealed that there were nonlethal attacks in Germany and Sweden over the New
Year holiday; the news apparently was initially suppressed by government officials.
In addition,
Iran boarded two US naval vessels, which reportedly drifted into Iranian
territorial waters accidentally, and took the sailors hostage. I think that the conservative press may have
gone in bit too far in its reporting of this incident. After all, what do you think the US would
have done if two Iranian boasts ‘drifted’ into US waters? On the other hand, the Iranians did push their
propaganda machine into overdrive and stepped over the line filming the
subjected sailors and demanding an apology.
The net of this is that it hurts the US’s already crippled standing in the
Middle East and thus negatively impacts whatever remaining leverage the US may
have in avoiding a disaster in the region.
(5)
economic difficulties in Europe and around the globe. This week saw largely negative data: UK
industrial production fell, Japanese core machinery orders plunged, Chinese
auto sales grew at the slowest rate in three years, Chinese exports and imports
fell and Chinese bank loan growth slowed.
In addition, a Bank of Japan official said that more QE would be
potentially harmful to the economy. There
was one upbeat number---Japanese consumer confidence was up slightly.
Eurozone half
measures (medium):
Massive Chinese debt looms over the
Market (medium):
In addition,
remember that sanctions against Iran will end soon and with it comes even more
oil choking the market. Given that lower
oil prices have been a negative for the global economy, then it seems
reasonable that more oil will likely be a weight on oil prices and hence an
even bigger negative for the global economy.
In sum, global economic stats continue to
deteriorate.
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.
The heavy cost
of economic failure (medium):
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up,
(2)
consumer: month to date retail chain store sales were down
versus the prior week; December retail sales and sales ex autos were below consensus;
weekly jobless claims rose more than forecast,
(3)
industry: December industrial production was below
forecast; the December small business optimism index was slightly above
projections; the January NY Fed manufacturing index was horrible: November
business inventories declined versus an anticipated flattening,
(4)
macroeconomic: December PPI was lower than expected; the
Atlanta Fed lowered its year over year GDP growth estimate twice; the December
Treasury budget deficit declined significantly; December import prices fell
less than forecast while export prices declined more than consensus.
The
Market-Disciplined Investing
Technical
Whew, rough
week. The indices (DJIA 15988, S&P 1880)
resumed their waterfall formation on Friday.
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 {16903-17665}, [c] in an intermediate term trading
range {15842-18295}, [d] in a long term uptrend {5471-19343}, [e] below its
August 2015 low and [f] 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] below the lower boundary of a short
term downtrend {1938-2028}, [d] in an intermediate term trading range
{1867-2134}, [e] in a long term uptrend {800-2161} [f] below its August 2015
low and [g] still within a series of lower highs.
Volume soared
(option expiration); breadth terrible.
The VIX was up 13%; but did not reach the levels of the August 2015 low,
indicating that there is still complacency out there. It ended [a] above its 100 day moving
average, now support and [b] in short term, intermediate term and long term
trading ranges.
The long Treasury
had a great week which it topped off with a 1.5% high volume advance on Friday. It finished above the upper boundary of its very
short term trading range; if it remains there through the close on Tuesday, it
will reset to an uptrend. It also ended above
its 100 day moving average, now support and within short term and intermediate
term trading ranges.
GLD was up 1%;
but still closed [a] below its 100 day moving average, now resistance and [b]
within short, intermediate and long term downtrends. I am really surprised that it can get no
upward momentum in a really crappy Market.
However, it does support the notion stated above that the level of
anxiety is relatively low.
Bottom line: that
Thursday bounce ended up being pretty pathetic relative to how oversold the
Market was. In Friday’s pin action, the
indices took out the early January lows and then proceeded to test (unsuccessfully)
the lower boundaries of their intermediate term trading ranges. While I think that there will be another
bounce because of the Averages’ extreme oversold condition, so much structural damage
has been done that it seems highly probable that they will retest the
15842/1867 levels.
As I noted
previously, those levels are very important because (1) they represent the
lower boundary of an important timeframe [intermediate term] and (2) the next
visible support levels are considerably lower [14256/1576].
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (15988)
finished this week about 29.6% above Fair Value (12333) while the S&P (1880)
closed 23.0% 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 horrid. That said, I am not yet
giving up on the notion that the recent string of positive data weeks could be
a sign that conditions are stabilizing---though clearly four mixed to upbeat
weeks in the last twenty is not a lot to hang that hope on.
Not helping is
that the global economy remains a mess, this week’s better ‘confidence’ data from
Japan notwithstanding. However, the
primary problem remains China’s slowing economy---which in turn has prompted
the government to devalue the yuan in order for its products to stay more price
competitive in the global markets.
Despite of a respite of sorts this week in the declining yuan, most
experts believe that there is more to come and are particularly fearful of the
government inexperience in handling such a move---the net effect of which could
be more pressure for competitive devaluations and disruptions in the currency
Market. Both are a bane not only to international
growth but also to global markets, including our own---indeed this has been a
primary contributor to the recent weakness in stock markets around the world.
Finally, the
heightened risk posed by the Saudi/Iranian cat fight, the lifting of sanctions
against Iran (its ability to sell oil plus a $150 billion cash bonus)
encourages mischief and the stepped up terrorist attacks around the world keep
this multifaceted explosive situation primed for any misstep turning into a
disaster.
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, stepped up terrorist attacks 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 the
Fed had to be on its knees praying for better economic numbers (the Beige Book
notwithstanding) and a turnaround in the Market. Concerning the former, it (along with the
president) has been pretending that there is economic progress while the data
has proven otherwise. But as I noted
above, this week St. Louis Fed head Bullard started whining about low oil price
and how they negatively impacting the Fed policy model---the implication being that
easier monetary policy could be in the offing.
Of course, oil prices don’t mean diddily to the Fed; but this week’s
Market plunge sure did. So it is clearly
worrying about having to manufacture a reason to back off its rate hike
strategy---because God forbid it admits that its monetary policy has been, is and
will likely continue to be totally f**ked up and that it can no longer pretend
that the economy is just great. Hence, the
Fed finds itself in a pickle. If it
responds to the Market decline by reversing itself, it will likely lose
investor confidence. On the other hand,
if it continues to raise rates in the face of poor data, it will probably
suffer the same consequence.
Meanwhile, the
Bank of China is struggling to get its economy and currency under control---and
at the moment that ain’t happenin’. If
the experts are correct and further yuan devaluation is on the way, then its monetary
policy will remain accommodative---creating a dichotomy with (current?) US tightening
and likely keeping downward pressure on global markets.
The Fed/Bank of
China faceoff (medium):
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.
Mohamed
El Erian on the Market (medium):
Bull, bear or humble?
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 1/31/16 12333
1528
Close this week 15988
1880
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.
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