3/26/16
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 -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 15431-17758
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 1867-2104
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 maybe providing a temporary upward bias to equity valuations. The stats
this week remained on the negative side of the ledger: above estimates: month to date retail chain
store sales, the February Markit flash services index, the March Richmond Fed
manufacturing index and fourth quarter GDP; below estimates: February existing
home sales, February new home sales, weekly mortgage and purchase applications,
February durable goods orders, the February Chicago Fed national activity
index, the March flash manufacturing PMI, the March Kansas City Fed
manufacturing index and weekly jobless claims; in line with estimates: none.
Likewise the
primary indicator were downbeat: fourth quarter GDP (+), February existing home
sales (-), February new home sales (-) and February durable goods orders (-) For those keeping a running score, in the
last 29 weeks, six have been positive to upbeat, twenty two negative and one
neutral. Finally, the Atlanta Fed
revised its first quarter GDP estimate down to 1.4%. This is the second downgrade in as many
weeks. Clearly these numbers support my
recent recession call, although I am still not dismissing the recent two week
run of upbeat stats.
In addition, oil
prices started to retreat again. It is
too soon to know if this is just some consolidation after the recent gains or a
realization that OPEC is just jerking the world off with its on-again, off-again
oil production freeze meetings. As I have oft repeated of late, (1) every
statistic and analysis of the oil market that I have seen is unsupportive of
the notion that the supply and demand of oil will be in balance anytime soon
and (2) history and politics suggest that OPEC will not freeze or lower output;
and if it does, the cheating will be so rampant as to make the freeze
irrelevant. The point here is less about
the actual price of oil and more about its impact on the financial condition of
both oil companies and the banks that lend to them---lower oil prices meaning
the increased likelihood of impaired balance sheets.
Another big
story of the week was the seeming walk back of the dovish tone coming out of
last week’s FOMC meeting. As I reported,
three regional Fed heads spoke this week in which they adopted a much more
aggressive stance towards a possible rate hike.
Indeed, the impression was that an increase could come as soon as April.
I covered this
subject in our Morning Calls; but to reiterate the bottom line: (1) nothing in
the data provides any reason for the dramatic shift in the Fed narrative;
indeed, as noted above, things have only gotten worse [see the newly revised
Atlanta Fed first quarter GDP forecast above], (2) continuing this back and
forth, on again, off again rate hike dialectic is likely to destroy what little
credibility the Fed still has left and (3) if the Mauldin thesis that I introduced
last week is correct, then this latest Fed speak is all bulls**t.
Just ask the
Chinese (short):
Theft by
government fiat (medium and a must read):
On the international
economic front, the numbers, what there was of them, were mixed, leaving the
current trend in global stats even worse than our own. Hence, there is nothing here to qualify as a positive
for our economy.
In summary, the US
economic stats this week were negative again while the international data sparse
and mixed. Meanwhile, the Fed is doing
its utmost to confuse and confound.
Our forecast:
a recession or a zero economic growth rate, caused
by 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, we received two pertinent news
items:
[a] Moody’s put Deutsche Bank on its
watch list for a credit downgrade,
[b] Canadian
bank regulators have determined that their banks are woefully under reserved. Immediately on the heels of that news, a
Canadian oil company declared bankruptcy after its bank called its loans. And to put a cherry on top, Canadian
regulators are proposing to make depositors of any bankrupt bank take equity in
the bank {versus their deposit}.
I am not going
to jump up and down on either of the above points {although the Canadian equity
cram down could severely impair the banks} except to say that global banks are
overleveraged with sufficient levels of nonperforming assets to keep us all up
at night. The above are but examples
thereof.
(2) fiscal/regulatory
policy. With the election season now in
full swing, we are likely to get no new developments by way of fiscal/regulatory
policy [except for more empty promises] until at least early 2017. Along those lines, it appears that republican
leaders have decided not to challenge Obama’s FY2016 budget in any meaningful
way. Shameful.
The eight
biggest barriers to economic growth (medium):
(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.
With the
completion of last week’s central bank trifecta, we were thankfully blessed
with little more cognitive dissonance from those yahoos. ‘Little’ being the operative word, because
the Fed did manage to confuse its own rate hike policy when three governors commented
in speeches that the economy was sufficiently strong to handle another rate hike,
possibly as soon as April---this but one week after the ultra-dovish statement
and Yellen press conference following the FOMC meeting.
I have railed
against this ‘on the one hand, on the other hand’ crap that we have been fed
for far too long. In my opinion, this is
another perfect example that the Fed has painted itself into a box, it knows it
and is trying to buy time by blowing smoke our skirts in the hopes that some
miracle will bail them.
The
inexorability of the numbers (medium):
In the
meantime, the Japanese yield curve is doing its best impression of the wave, demonstrating that the Fed is not the
only central bank that is in a corner and doesn’t know how get out. Even worse, on Thursday, there was an unsubstantiated
report that Japan will unveil its version of ‘helicopter’ money [checks to poor
citizens that can’t be deposited, ergo, must be spent]. What could possibly go
wrong with that?
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 terrorists’ bombing in Brussels clearly added to the concerns about
radical islam whether in the Middle East or closer to home. As I noted
last week, all this takes is one final explosive event to turn propel this risk
to center stage.
This is an
excellent article on the danger posed by the willful ignorance of islam by
western leadership (medium and a must read):
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week were sparse and mixed: February
Chinese auto sales plunged 44%; the March EU Markit composite PMI came in
better than anticipated while UK inflation was reported at zero; and German
business confidence rose, though I suspect the Brussels bombing will negate that.
In other news, (1) Greece and its creditors were still
unable to reach an agreement on a third bailout and (2) Iran said that it would
consider joining in an oil production freeze ‘at a later time’. I have no idea what that means and it is
likely that neither do all those folks who were making bets on it.
The bottom line: what data we got
was not encouraging. The global economy remains
a major headwind.
Bottom line: this week’s US data points toward a recession,
though I continue to stew over whether I acted too quickly in making that call. The global economy did nothing to brighten
the outlook. Meanwhile, the global central banks are doing
everything possible to confuse and confound the Markets in hopes that a miracle
allow them to exit QE without much damage.
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: February existing home sales was down twice
what was expected while new home sales were less than projected; weekly
mortgage and purchase applications declined,
(2)
consumer: month to date retail sales grew more than in
the prior week; weekly jobless claims increased more than consensus,
(3)
industry: February durable goods orders were down, ex
transportation, they were especially disappointing; February Chicago Fed
national activity index was extremely poor; the March flash manufacturing PMI
was below estimates, however the services PMI was better than projected; the
March Richmond Fed manufacturing index was much better than anticipated while
the Kansas City Fed index was much worse,
(4)
macroeconomic: the final revision of fourth quarter GDP
was reported at +1.4% versus consensus of +1.0.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17515, S&P 2035) churned in place Thursday, again on very low volume
and mixed breadth. The VIX was off
fractionally, but continues to support high and rising equity prices.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] in a short term a trading range {15431-17758}, [c] in
an intermediate term trading range {15842-18295} and [d] in a long term uptrend
{5471-19343}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term trading range {1867-2104},
[d] in an intermediate term trading range {1867-2134} and [e] in a long term
uptrend {800-2161}.
The long
Treasury moved up again, voiding a very short term downtrend and remaining
above a Fibonacci support level. After a
six week period of consolidation, this may be a sign that the recent decline is
over.
GLD was
lower. While it remains within a short
term uptrend and above its 100 day moving average, it is still above visible
support. So more consolidation seems
likely.
Bottom line: the indices continue their solid performance
given how over extended they were and the amount of negative news they have had
to overcome this week. True low volume
and mixed breadth are not helpful. Plus
both voided very short term uptrends.
That said, they have plenty of near end support. So my assumption remains that they challenge their
all-time highs until/unless they negate the aforementioned support levels.
Broadest index
hitting resistance (short):
The latest from
Doug Kass (medium):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17515)
finished this week about 41.2% above Fair Value (12399) while the S&P (2035)
closed 32.5% overvalued (1535). 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 this week was again quite negative, putting that recent two streak of
upbeat numbers further behind us.
Clearly, the more poor stats we get, the stronger my case for
recession.
Not helping
matters, oil prices reversed their recent strong uptrend. This may be just some consolidation after a
big run up; but if it is more than that, then the lack of financial viability
of many oil companies and the banks that serve them is back on the table. And as I have noted several times, there is currently
little evidence to support higher oil prices.
In sum, if our forecast
is anywhere near correct, most Street forecasts for the economy, corporate
earnings and, hence, stock valuations are too high.
As always, Fed
policy will play a role in Street formulations.
Last week, the central banks delivered what investors wanted in the form
of triple down, QE forever policies---which in turn helped stocks continue to
rally. As you know, I think that that
game will be over when investors finally realize that QE (except QE1) hasn’t,
isn’t and likely won’t do anything to improve the outlook for the economy or
corporate profits. Clearly the operative
word in that statement is ‘when’. Based
on my record of late, I don’t have a clue ‘when’ is. I only note that the more the Fed pursues
this dovish/hawkish double talk, the more likely the ‘when’ is sooner rather
than later. Unfortunately, as long as investors’
ill-conceived euphoria lasts, mispriced assets will remain in nosebleed
territory.
When it ends, I believe
that the cash generated by following our Price Discipline will be welcome as
investors wake up to the Fed’s (and other central bank) malfeasance because I
suspect the results will not be pretty.
The Fed’s impact
on stock valuation (medium and a must read):
A bunny market
(short):
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.
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.
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 3/31/16 12399
1535
Close this week 17515
2035
Over Valuation vs. 3/31 Close
5% overvalued 13018 1611
10%
overvalued 13638 1688
15%
overvalued 14258 1765
20%
overvalued 14878 1842
25%
overvalued 15498 1918
30%
overvalued 16118 1995
35%
overvalued 16738 2072
40%
overvalued 17358 2149
45%
overvalued 17978 2225
Under Valuation vs. 3/31 Close
5%
undervalued 11779
1458
10%undervalued 11159 1381
15%undervalued 10539 1304
* 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.
