The Closing Bell
3/12/16
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 16655-17426
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. There
were few stats released this week and what was, was mixed to negative: above
estimates: weekly mortgage and purchase applications, month to date retail
chain store sales, week jobless claims and February US import and export prices;
below estimates: the February small business optimism index, January consumer
credit, the February wholesale inventory/sales numbers and the February budget
deficit as well as the trade deficit; in line with estimates: none.
In addition, there
were no primary indicators reported. So in the economic stats record book, this
week hardly existed. I do think that the
negative data carried more weight than the positive did. However, that may just be me talking my book.
Bottom line, I don’t think that this week even
qualifies to be rated. That leaves our forecast unchanged and me still stewing
over whether I jumped the gun on my recession call.
Nevertheless,
higher oil prices are raising hopes that oil industry recession is over and
that will lead to an improvement in the gross economic numbers. I can buy the idea that the worst may be over
but to assume conditions are going to improve anytime soon is probably pushing
it. Every oil industry statistic I have
seen indicates that supply/demand won’t be in balance for at least another
year. Yes, we could get some production
cuts but I think that is wishful thinking.
However, what is more likely is demand reduction due to a lousy economy. So the optimism stemming from recent lift in
oil prices may be a bit premature.
The Fed was
quiet this week; though Fed whisperer Hilsenrath suggested that the
Fed would likely do nothing next week.
Fed would likely do nothing next week.
While somewhat
sparse, the international economic numbers were mixed for the first time in a
number of weeks. But I wouldn’t qualify
them as being positive for our own economy.
The big news of
the week was (1) the ECB meeting in which Draghi rolled out a howitzer and (2)
a proposal [now being drafted into law] from the Chinese government that would
allow banks to convert their nonperforming loans to equity, freeing up their
balance sheets to lend more money and (3) another on again, off again round
trip on a possible meeting of oil producers.
In summary, the US
economic stats this week were virtually meaningless and the international data was
sparse and mixed. Meanwhile, the central
bankers have quadrupled down on QE and negative interest rates---which if
history repeats itself, I suspect will end up looking like Custer’s last stand.
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. No news this week.
(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.
This was the
principal focus of economists and investors alike this week.
The ECB gave
the world the full Monty, lowering interest rates, jacking up QE and expanding
the assets that qualify for central bank purchases. That is more than most everyone had hoped
for. Later, Draghi said that there would
be no further rate reductions. I think
that reflects his realization [finally] that if this latest round of QE doesn’t
work, no additional amount of QE ever will.
And if history is any guide, it won’t.
At that point, surely he and every other central banker in the universe
will face the ugly truth that this was, is and always will be a failed
policy.
Hopefully, the
central bankers will recognize the error of their ways and do something
helpful---like normalize monetary policy. Of course, these academics have perfected
the art shutting out cognitive dissonance.
So who knows what they will do? But at that point, it likely won’t matter,
because the rest of the world will see that the emperor has no clothes and
start acting accordingly, i.e. undoing the damage of asset mispricing and
misallocation. My hope is that this week’s
ECB actions are the beginning of the end.
In addition,
the Chinese government announced that a rule was being drafted to have its
banks convert all nonperforming loans to equity, freeing up their balance
sheets for more lending. Yeah, that
ought to work: nationalize all those failed companies [remember the government
is a major owner of the banks] and then let the banks lend them even more
money. I recall the phrase ‘throwing
good money after bad’. The only hope the
Chinese have is that someone will figure out what a disaster that policy would
be and squelch it.
Finally, of
considerably lesser importance, the Bank of New Zealand lowered its key
interest rates. As I noted on Thursday,
this action isn’t going to change anybody’s global economic forecast. But it could encourage other countries to
join the crowd of competitive devaluations.
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.
The central banks
are clueless (medium and today’s must read: http://www.realclearmarkets.com/articles/2016/03/11/central_bankers_really_dont_know_what_theyre_doing_102057.html
The Fed has a problem
(medium):
(4) geopolitical
risks: Iran threatened to walk away from the nuclear deal. Of course, it never intended to honor the
terms in the first place, so this isn’t exactly a big surprise. The big question is what will Obama do, if it
does?
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week were also sparse and somewhat mixed: January German factory orders fell though its
industrial production rose, February Chinese exports and imports plunged and
CPI shot up 2.3%.
The bottom line, like the US dataflow, not much volume this week though
what we got was not encouraging. The
global economy remains a major headwind.
In
addition, the oil producers threw the rest of the world another head fake this
week, first announcing a meeting on March 20 of both OPEC and non OPEC
producers [ostensively to discuss production levels] and then reversed
itself. I am convinced these guys are
trading off their own announcements and laughing their way to the bank.
In sum, the global
economic outlook has not improved.
Bottom line: this week’s US data was of no informational
value, though I continue to stew over whether I acted too quickly in calling for
a recession. The global economy did
nothing to brighten the outlook. Meanwhile, the ECB and the Bank of China may
have used their last QE bullet, leaving us all to contemplate what happens next.
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: weekly mortgage and purchase applications were
up,
(2)
consumer: January consumer credit grew much slower than
expected; month to date retail chain store sales was up slightly versus the
prior week; weekly jobless claims fell more than anticipated,
(3)
industry: the February small business optimism index
was lower than estimates; January wholesale inventories rose but only because
sales plunged,
(4)
macroeconomic: the February US budget deficit came in slightly
greater than forecast; February import and
export prices fell less than projected.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17231, S&P 2022) had a volatile week but ended on a very strong
note. Volatility has been cut in half in
the last four weeks and is getting close to a level that offers an attractive
value as portfolio insurance. Meanwhile,
the current advance has been on low volume and mixed breadth.
The Dow closed
[a] above its 100 day moving average, now resistance; if it remains there
through the close on Tuesday, it will revert to support, [b] above its 200 day
moving average, now resistance; if it remains there through the close on Wednesday,
it will revert to support, [c] above the lower boundary of a short term
downtrend {16655-17386}, [c] in an intermediate term trading range
{15842-18295}, [d] in a long term uptrend {5471-19343}, [e] and has made a
third higher high and is working on a fourth.
The S&P
finished [a] above its 100 day moving average, now resistance; if it remains
there through the close on Tuesday, it will revert to support, [b] above its
200 day moving average, now resistance; if it remains there through the close
on Wednesday, it will revert to support, [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] has made a second higher high and is working on a
third.
The long
Treasury continued to drift lower, but not enough to challenge its short term
uptrend or its 100 day moving average.
However, it has developed a very short term downtrend and busted through
a key Fibonacci retracement level. Since
the global central banks are cutting rates (higher bond prices), this pin action
only makes sense if investors are in a risk-on mood (sell safety, buy risk).
GLD spent the
week consolidating after a massive run higher.
It still looks a bit overextended to me.
But it has held its very short term and short term uptrends, as well as remaining
substantially above its 100 moving average.
Bottom line: the
bulls maintained control despite the Market being extremely overbought. The indices have pushed through, though not
confirmed the break of, two major moving averages.
After a big day
like Friday, it is easy to get concerned about being left behind on the upside. But remember (1) the breaks of the 100 and
200 day moving averages have yet to be confirmed, (2) neither the short or intermediate
term trends are up and (3) the upper boundary of the S&P long term uptrend is
only 6% away.
That said, I
have been harping all week on how overbought stocks were, how puny the volume has
been and the lack of real power in the breadth; and prices keep going up
anyway. So what do I know?
However wrong I may
have been reading the tea leaves short term, I still believe that the bull
market is likely over and that mean reversion is the principal risk right now.
Update on best
stock market indicator ever (medium):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17386)
finished this week about 40.2% above Fair Value (12399) while the S&P (2022)
closed 31.7% 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.
We received no
new information on the US economy this week, leaving me sticking with my
recession forecast---but a little uneasy about it. On the other hand, (1) the US corporate revenue,
earnings and dividend data are getting worse and (2) the global economic data remains
discouraging; both of which support my outlook.
If correct, many Street economic
forecasts are too optimistic; and if (when) they are revised down, it will
likely be accompanied by lower Valuation estimates. (must read):
That said,
investors have been jiggy of late because of
(1) the
perception of a declining probability of recession. That could happen but even if there is no
recession, US growth will still be subpar at best, the world economy continues
to stink [so no help there] and the rest of the globe’s central bankers are
driving to hoop on devaluation---which, to date, has been a big fat minus for
US corporate revenues and profits,
(2) more
and more QE. With the ECB’s new and
improved monetary easing, we may just have seen the last and best attempt to
prove this policy works. If this newest
version is a dud, like all the rest, then hopefully it will prompt a great
re-think of the value of QE/negative interest rates---which the Markets will
undoubtedly not like.
And
unfortunately, there is potentially even more, if the Chinese go through with
the latest proposal to cram down bank debt into the equity of virtually bankrupt companies so that the Bank of China
can provide more money to lend to more virtually bankrupt companies. What could go wrong here?
(3) higher
oil price. Do you remember when not so
long ago lower oil price were [supposed to be] a major plus? My how things change. Now everyone is praying for OPEC to cut
production, allowing oil prices to rise thereby avoiding multiple bankruptcies
that could threaten the banking system.
However, even
if oil prices do stabilize and oil industry bankruptcies are minimized, that is
not going to correct the overall weakness in the financial system. I repeat in these notes chapter and verse
every week about the problems in global banking system. This week’s hair brain scheme by the Chinese to
somehow paper over billions and billions of nonperforming loans is another
perfect example.
While the US
banks may have improved their balance sheets, the rest of the world’s banking system
is much more highly leveraged and packed with bad loans many of which were made
with government encouragement. Those
aren’t going away whatever happens to the price of oil.
Unfortunately, as
long as this 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 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.
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 17386
2022
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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