The Closing Bell
1/23/16
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 16872-17620
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 1929-2018
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: December existing
home sales, weekly mortgage applications, the January flash PMI; below
estimates: December housing starts and building permits, weekly purchase
applications, the January homebuilders’ confidence index, month to date retail
chain store sales, weekly jobless claims, the December Chicago Fed national
activity index, and December CPI; mixed results: the December/January Philly
Fed index and the November/December leading economic indicators.
The primary indicators
were mixed: December housing starts and building permits (-), existing home
sales (+) and leading economic indicators (0)---so no real upward bias to
offset the magnitude of the negative stats.
The Fed thankfully kept its mouth shut---likely because of being paralyzed
with fear.
In sum, the data
this week remained negative, though it was hardly overwhelmingly so. Still it
did not help the thesis that the economy has found a new level of slower growth
(four mixed to upbeat weeks and seventeen negative weeks in the last twenty-one). Indeed, it is starting to look like that sporadic
string on mixed to positive weeks was little more than a gratuitous
hiccup. A couple more weeks of solidly
negative data, I will likely revise our forecast even lower with a strong
probability of recession.
The international
data was again disappointing with particularly weak numbers out of China. In addition, the IMF and a former official
from the BIS joined the skeptics on the global economy. 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 not good; 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 became a bit unsettling. Following the problems in the Portuguese
banks mentioned last week:
[a] several Italian banks disclosed that they were insolvent,
[b] the former chief economist with the BIS warned that the
world faces multiple bank defaults,
[c] Deutschebank recorded a $7 billion loss.
And this (must read):
As you may recall, when first listing this factor as an
economic negative, my primary concern was for our own banking system. However, as I have pointed out, a number of
steps by regulators has led to more capital on US bank balance sheets and well
as their exit from many of the speculative trading and lending policies that
led to the 2008/2009 financial crisis.
To be sure, that is a plus especially for the US banking system.
Of course, that didn’t eliminate speculative behavior, it
just transferred into other financial systems.
Now we are getting warnings from multiple countries about troubles with
their banks as well as the Chinese and Saudi governments attempting to quell
speculation in their respective currencies.
Clearly, potential bank defaults/insolvencies and unstable
currencies do not bode well for global or US economic activity.
(2) fiscal/regulatory
policy. Not much news this week. Though one development holds great hope. The Supreme Court has agreed to hear a case
involving Obama’s mandated immigration policies. As part of that review, the Court asked the
parties to comment on whether or not the executive branch has the
constitutional authority to propound and enforce those regulations. (must read):
We should all
get down on our knees and pray that the Court rules this a usurpation of power
by the executive branch. If so, multiple
new cases will hopefully brought related to other executive issued regulation
and the states/people will be given a weapon to combat presidential overstep of
authority.
(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.
Who wants to
bet on whether or not the Fed will reverse its recent rate hike? With its most important objective [higher
stock prices] rapidly becoming a wet dream, these guys must be deep into prayer
mode. One would think that no amount of
rationalization could possibly allow them to avoid the realization that their
failed QE policies have done nothing to improve the economy and, indeed have
only made things worse---like the mispricing of assets which may now becoming manifest
in stock prices. The operative words
being ‘one would think’. Regrettably, in
the 46 years I have been a Market participant, I have never ceased to be amazed
at the ability of bureaucrats, especially egghead bureaucrats, to ignore the
truth in front of them, double down on an already failed policy or come up with
something just as dim witted and imprudent.
God only knows
what the Fed will come up with next. But
the odds of its escaping the consequences of a seven year reckless monetary
policy appear to be quite low at the moment.
In short, it appears likely that the Markets are beginning to inherit
the results of years of asset mispricing and misallocation
Laughing
at the Fed (a bit long but today’s absolute must read):
All that
said, the Chinese continue to pump liquidity into their financial system; and
this week, Draghi, in his usual Oracle of Delphi presentation, promised that
the ECB will continue to monitor the EU economy and if more stimulus is needed
it will be forthcoming [data dependent anyone?]. And to put a cherry on top, after poo pooing
further QE as useless, the Bank of Japan is rejoining the ranks of the QE’ers. So it appears that there is no end to the
heavy injection of money into the global economy---despite the fact that it has
done no good for anyone.
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: things are about to get really interesting in the Middle East. With the sanctions over and a new war chest
of $150 billion, who knows what kind of mischief the Iranians can unleash. Unfortunately, we may are about to find out.
(5)
economic difficulties in Europe and around the globe. This week, it was reported that fourth quarter
Chinese GDP grew at the slowest rate in
25 years, December Chinese industrial output, retail sales and fixed
investments were all below expectations, January Markit EU composite flash PMI
fell to the lowest level in eleven months and the IMF lowered its 2016/2017
global growth estimates.
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.
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. 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.
This week’s
data:
(1)
housing: December housing starts and building permits
were disappointing; December existing home sales were up more than forecast; weekly
mortgage applications were up, but purchase applications were down; January
homebuilders confidence was lower than expected,
(2)
consumer: month to date retail chain store sales were down
versus the prior week; weekly jobless claims were short of estimates,
(3)
industry: the January Philly Fed manufacturing index was
down slightly less than anticipated, but the December reading was revised down
substantially; the Chicago Fed national activity index was down big; the
January flash PMI was better than forecast,
(4)
macroeconomic: December leading economic indicators
were better than consensus, but the November reading was revised substantially;
December CPI was lower than expected.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 16073, S&P 1906) closed up on Friday after an 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] below the lower boundary of a short
term downtrend {1929-2018}, [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 was flat;
breadth improved. The VIX was down 16%
but 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 good week but closed lower on Friday. It finished above its 100 day moving average,
now support and within short term and intermediate term trading ranges.
GLD was down,
remaining [a] below its 100 day moving average, now resistance and [b] within
short, intermediate and long term downtrends.
Bottom line: at
the end of the week, we finally got the much anticipated oversold bounce. Now the big question on everyone’s mind is, is
it truly an oversold bounce (i.e. fizzle out and then make new lows) or was the
Thursday/Friday turnaround the end of a correction? Of course, no one knows. But there are guideposts for answer. They include the indices’ 100 day moving averages,
the upper boundaries of their short term downtrends and an important
retracement level (circa S&P 1928). Until
one or more of those resistance levels are successfully challenged, the
prevailing assumption is that there is more downside.
Is the bottom in
(medium):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (16073)
finished this week about 30.3% above Fair Value (12333) while the S&P (1906)
closed 24.7% 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.
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
incline. The global economy remains a
mess---the primary focus now centered on a slowing Chinese economy and the
probability of further big declines in the yuan. However, not to be ignored is the fragility
of global banks---a problem that is getting increased attention, at least from
the experts.
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 economy
is almost surely slowing, edging ever closer to tipping over into recession. In the meantime, the global economy is lousy,
its banking system increasing infirm, the Chinese ruling class is unsuccessfully
thrashing around attempting to halt the decline in economic activity and the weakness
in its currency and the escalation of tension in the Middle East raises the
risk of some untoward event igniting all-out war. The risk here is that many Street economic forecasts
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 likely maintained its latest principal policy position---prostration,
praying the Market rebounds.
Unfortunately for this group, nothing undoes asset mispricing and
misallocation like a good old fashion dose of reality---which we appear to be
getting in spades. The truth is that the
Fed is 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, most
of the other major central banks continue to 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. Fat chance. That
said, judging by Thursday and Friday’s pin action, investors apparently are still
wedded to the notion that QE is a plus.
Frankly, that is how we know that the worse isn’t over. Until investors realize that QE (except QE1)
has been nothing but a giant clusterf**k and it sole achievement has been to
fund the mispricing and misallocation of assets, sooner or later, the worst is
yet to come.
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 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 16073
1906
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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