The Closing Bell
3/5/16
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 Downtrend 16678-17426
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. This
week’s dataflow by volume was overwhelming negative: above estimates: the
February ADP private payroll report, February nonfarm payrolls, the February
ISM manufacturing and nonmanufacturing indices, January construction spending,
fourth quarter productivity and unit labor costs; below estimates: weekly
mortgage and purchase applications, January pending home sales, month to date
retail chain store sales, February light vehicle sales, weekly jobless claims,
the February Chicago PMI, the February Markit nonmanufacturing PMI, January
factory orders, the February Dallas Fed manufacturing index and the January
trade deficit; in line with estimates: the February Markit manufacturing PMI.
In addition, the
most recent Fed Beige Book was released this week and painted a picture of an
economy generating slow growth---sort of like our prior outlook.
However, the
primary indicators were strongly upbeat: February ISM manufacturing and
nonmanufacturing indices (++), fourth quarter productivity and unit labor costs
(++), January construction spending (+), February nonfarm payrolls (+) and
January factory orders (-).
While the
overall showing was weak, the strength in the primary indicators for the second
week in a row not only raises more questions regarding my newly revised
forecast but also gives hopes to investors that recession is off the table. Nevertheless, two factors holding me back
from any changes at this time: (1) the longer term trend is still quite
negative---six mixed to upbeat weeks and twenty negative weeks in the last
twenty-six weeks; though clearly two positive weeks in a row is something of
short term trend, and (2) this week’s revelation by the Bureau of Economic
Activity that it had raised the seasonal adjustment factors because of the two
prior hard winters---the net effect of which is to raise this year’s seasonally
adjusted raw data in what has been a mild winter. In other words, this year’s numbers could be
overstated.
The economy in
nine charts (short):
I am not arguing
that we ignore the past two weeks’ positive data. I am saying that there is reason to pause
before taking them at full face value.
The impact on our forecast will be to delay a reversal of my recent
revised forecast, if at all. Further, I
point out that even if I do revise again, it will still reflect an economy that
is struggling to grow.
New York Fed
chief Dudley reiterated St Louis Fed head Bullard’s comments last week in which
he proclaimed that the economy was just fine but that another interest hike
could be harmful. That may likely be a sign
that nothing will occur at the Fed’s March meeting except more oblique
commentary.
In sum, the US stats
overall this week were negative but the primary indicators were quite positive
for a second week in a row. Certainly, I
am wondering if I jumped the gun on my recession call; however, more data is
needed before I get too serious about it.
The international
economic numbers we got were terrible.
Plus, worries continued to mount regarding the strength of European bank
balance sheets. So no help for the US
from this source.
Importantly, the
G20 met this week and produced little of substance except a recommendation of
less QE and more fiscal stimulus.
However, immediately following that meeting, both Japan and China
announced policies that were the exact opposite of the G20 recommendation. In addition, the ECB meets next week and,
based on a recent letter from Draghi to member states, expectations are that
further QE and/or negative interest rates will be authorized.
In summary, the US
economic stats this week were better than what has been the norm of late but the
international data were very poor.
Meanwhile, the central bankers are pursuing the same old tired,
ineffective policies that got us into this mess in the first place.
Jim Rogers: 100%
probability of a recession within a year (4 minute video):
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, the only datapoints we received were
anecdotal:
[a] Barclay’s cut its dividend. Certainly, not enough to get exercised over;
but it is another sign of financial weakness among the major global banks.
[b] energy company default rates are rising and the
recovery rates [what the debt holders ultimately recoup] are declining
(medium):
[c] the market for bulk shipping has never been worse, so
the entities financing them face problems (short):
[d] and on a
brighter note, the Fed is proposing to limit the counterparty exposure of the
TBTF banks (medium and good for the Fed):
(2) fiscal/regulatory
policy. With the election season now in
full swing, we are likely to get no new developments by way of fiscal policy [except
for more empty promises] until at least early 2017. On the other hand, Obama could continue or
even step up His efforts to impose new regulations on the economy via executive
action---anything to build a legacy.
(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.
News flash, Fed
discovers problems in the student and auto loan markets (medium):
The news this
week included [a] the G20 doing nothing but yakking about needed fiscal
stimulus [b] immediately thereafter, Japan confirmed that it would go through
with its planned sales tax hike and China provided additional liquidity to its
financial system, [c] New York Fed chief Dudley supported Bullard’s comments
from last week that more rate increases at this time are unnecessary, and [d]
Draghi sent a letter to the ECB’s member sovereign bankers reiterating his
‘whatever is necessary’ theme.
In last week’s
Closing Bell I said: ‘Of course, the G20 could always agree to pursue
more of the same useless QE or negative interest rate policies as some sort of
substitute for fiscal action. And
barring a dramatic turnaround among the policy makers that would likely be
exactly what they do. Which is to say more
Keynesian monetary stimulus in the hopes of generating consumer spending’.
I would love to
claim prescience, but I was doing nothing but extrapolating past performance
into the future. These guys are too
arrogant to ever learn from their mistakes.
Nothing that they have done thus far has worked and any add on QE or
negative interest rate policies will likely only make matters worse.
However as
usual, those policies continue to inject euphoria among the stock guys because
the central bankers’ only true accomplishment has been to drive asset prices
ever higher as earnings decline ever further.
Sooner or later something has to give because the logical conclusion of
this trend is to pay infinity for no earnings/no earnings growth. I think it likely to be ugly when that
happens.
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.
There is no clear way out (medium and a
must read):
(4) geopolitical
risks: the cease fire in Syria appears to need a second tweaking, whatever that
means. My chief concern is that if the
Saudi’s/Turks keep getting more involved, there is the potential that they get
their collective asses kicked by the Russians and then come whining to us to do
something.
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week were awful…again: the February EU CPI declined, the February Markit EU
composite PMI fell to a 13 month low while the February UK services index
declined to a three year low, both the February Chinese manufacturing and
services PMI’s and the February EU manufacturing PMI declined, South Korean
factory output as well as exports fell, Moody’s reduced China’s credit rating. The bottom line here is that whether or not
the US economy is doing better than I may have thought, it is getting no help
from abroad. Indeed, the global economy
is a major headwind.
In a somewhat
related matter, the US imposed tariffs on cold rolled steel. The chief source of the problem is China
dumping its excess production; and, hence, our actions are most likely justified. However, it doesn’t mean any less with
respect to the growing ‘beggar thy neighbor’ trend most visibly manifest of
late in currency devaluation. The cause
is still the same---a shrinking global economy, resulting in excess production
which motivates countries to cheapen exports in order to keep employment rates
up. And the outcome is still the
same---everyone does it to preserve market share and ultimately a trade war
ensues that is both deflationary and recessionary.
In sum, the global
economic outlook has not improved and if US imposed tariffs are a sign of
things to come, it has gotten worse.
Bottom line: the aggregate US dataflow continues to point
to a recession though the last two week’s primary indicators give me pause. On the other hand, the global economy did
nothing to brighten the outlook. Meanwhile, the central bankers are doing what
they do best---which is to pursue policies that haven’t worked, aren’t working
and likely will never work.
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: January pending home sales declined versus an
expected increase; weekly mortgage and purchase applications dropped,
(2)
consumer: month to date retail chain store sales growth
fell versus the prior week; February light vehicle sales were less than
forecast; February nonfarm payrolls were better than projections; the February
ADP private payroll report showed job growth stronger than estimates; weekly
jobless claims were above consensus,
(3)
industry: both the February ISM manufacturing and
nonmanufacturing indices were better than anticipated; the February Chicago PMI
was well below forecast; the February Dallas Fed manufacturing index was below
consensus; the February Markit manufacturing PMI was in line, while the
services PMI was lower than expected; January factory order were disappointing;
January construction spending was above projections,
(4)
macroeconomic: fourth quarter productivity fell less
than forecast, while unit labor costs rose less than expected; the January
trade deficit was larger than estimated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17006, S&P 1999) had another great up week, as volatility declined,
volume remained low and breadth mixed.
The Dow closed
[a] below its 100 day moving average, now resistance, [b] below its 200 day
moving average, now resistance, [c] above the lower boundary of a short term
downtrend {16678-17426}, [c] in an intermediate term trading range {15842-18295},
[d] in a long term uptrend {5471-19343}, [e] and is developing a third higher
high.
The S&P
finished [a] right on its 100 day moving average, now resistance, [b] below its
200 day moving average, now resistance [c] within a short term trading range {1867-2104},
[d] in an intermediate term trading range {1867-2134}, [e] in a long term
uptrend {800-2161} and [f] is developing a second higher high.
Forecasting an
incumbent party defeat? (short):
The long
Treasury continued to drift lower, enough to break its very short term uptrend
but not enough challenge its short term uptrend, its 100 day moving average and
a key Fibonacci retracement level. This
pin action is to be expected in the current risk on trade (sell bonds, buy
stocks) environment.
GLD ended in
very short term and short term uptrends, as well as substantially above its 100
moving average. However, the rally is
getting a bit overextended. In fact, it
could retreat circa 4% and not challenge its very short term uptrend.
Blackrock
suspends new share issues of gold ETF:
Bottom line: the
bulls controlled the week. The S&P
broke its short term downtrend and is challenging its 100 day moving
average. The Dow is trailing on both
counts, so I don’t see an open field to the all-time highs. But clearly the bulls are on the
offense. Nevertheless, I don’t know how
there can be much short term follow through from current levels because of the
extreme overbought condition of the Market, the lack of volume and the
continued divergences.
That doesn’t
mean that stocks can’t consolidate and then mount an upward assault
eventually. It just doesn’t seem likely
now. In any case, when, as and if stocks
do go higher, I remain firmly convinced that [a] we will not see a new all-time
high and [b] we haven’t seen the lows of this cycle yet.
Update on best
stock market indicator ever (short):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17006)
finished this week about 37.1% above Fair Value (12399) while the S&P (1999)
closed 30.2% 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 primary
indicators were very strong again this week.
Two weeks in a row represents something of trend; though we need (1) more
data and (2) clarity on the effect of the revised seasonal adjustment
factors. However, even if I ultimately
reverse my recent recession call and move back of a ‘sluggish growth’ scenario,
the global economy will help keep a lid on US growth at a minimum and could
push us into recession anyway---and that assumes no crisis in the financial
system or an expanded war in the Middle East.
This along with the recent data showing declining earnings growth and
increased dividend cuts suggest that many Street economic forecasts are too
optimistic; and if (when) they are revised down, it will likely be accompanied
by lower Valuation estimates.
That said, I think
that the current rally is being at least partially driven by investor
perceptions that a recession is declining probability---which may be true. Though if there is any economic growth, it
will be paltry at best and do little to help EPS or dividend growth.
This week, New
York Fed chief Dudley supported the notion that ‘another rate hike would be
unwise’. In addition, the latest Fed
Beige Book portrayed an economy progressing very slowly. I think that this means no rate increase in
the Fed’s March meeting.
In addition, (1)
the Bank of China has already pushed more liquidity into its financial system,
(2) Draghi has given a firm sign that new QE measures will be introduced in
next week’s ECB meeting and (3) given its history, there is no telling what the
Bank of Japan will do in its upcoming meeting.
Of course, the Markets
clearly continue to love QE despite its lengthy, abysmal record in generating
economic growth. Plus as I noted above,
the perception that recession is no longer on the table gives investors a
goldilocks investment scenario. Regrettably, as long as this ill-conceived
euphoria lasts, mispriced assets will remain in nosebleed territory. Long term, I believe that the longer easy
money policies of the central banks last 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.
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.
More on
dividends (short):
More on earnings
(medium):
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. 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 3/31/16 12399
1535
Close this week 17006
1999
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
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.
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