The Closing Bell
4/30/16
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 Uptrend 17692-18646
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5541-19413
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend (?) 2106-2208
Intermediate
Trading Range 1867-2134
Long Term Uptrend 830-2218
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. The
stats this week were again weighted to the negative: above estimates: month to date retail chain
store sales, weekly jobless claims, March personal income, the April Richmond
Fed manufacturing index, the March trade deficit; below estimates: weekly
mortgage and purchase applications, March new home sales, April consumer
confidence and consumer sentiment, March personal spending, March durable goods
orders, the April Chicago PMI, the April Dallas Fed manufacturing index and
first quarter GDP; in line with estimates: the February Case Shiller home price
index.
The primary
indicators were also negative: the March personal income (+), March new home
sales (-), March personal spending (-) and March durable goods (-). In the last 34 weeks, seven have been positive
to upbeat, twenty six negative and one neutral.
On the other
hand, this week’s international economic stats, especially from Europe, were largely
to the plus side--- something that hasn’t happened for months. It is, of course, far too soon to assume that
this is the first sign of a turnaround in the EU economy; but it could be. We just have to wait for more data.
The Fed
maintained its ‘when confused, dazzle them with your bulls**t’ routine following
the latest FOMC meeting. On the other
hand, the Bank of Japan gave the world a real shocker by doing nothing at its
meeting this week. The reasoning is not entirely
clear as yet; but it appears that the US gave them a stern warning (see below). But whatever it was, the world is a better
place because its inaction.
In summary, the US
economic stats were negative while the international data was surprisingly
upbeat. Meanwhile, I am hoping that the
BOJ’s inertia is the first sign of the end of egregious central bank overreach.
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 is a great interview with Jim Bianco on
negative rates and global banking system:
US banks are certainly in stronger financial condition than
in 2008. That doesn’t mean that all is
well in ‘too big to fail’ land.
(2) fiscal/regulatory
policy. A follow up to last week’s Central
States pension insolvency: I noted that
it was likely not an isolated incident.
Well, it didn’t take long for the second shoe to drop. In this case, a UK retirement plan that is
converting from a defined benefit to a defined contribution plan---in other
words, a cut in benefits. The ultimate consequence:
lower consumer spending.
The shockingly
high cost of federal regulations (medium):
The future problem of rising
debt levels (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.
The Fed policy
statement this week pretty much followed the expected script which was in a
word---nondescript. More mealy mouth
blather, again confirming these guys (and gal) have tied themselves in a granny
knot and have no clue what to do next.
On the other hand,
the Bank of Japan surprised almost everyone by doing nothing. Initially, I hoped that it might reflect the
recognition that this whole aggressive central bank intervention policy has
come to naught. But the real reason is
apparently a warning from the US Treasury to cease and desist any currency
devaluation policies [this in the name of unfair trade practices]. Sounds familiar to the supposed warning from
the Chinese at the last G20 meeting. The
attached article makes it sound like the whole G20 had a ‘come to Jesus’ agreement
to stop such practices. I have a hard
time buying that.
But it doesn’t
really matter what the cause was because the effect is all that counts---and
that is that China, the US or both basically told the rest of the world to either
stop any policies that could be viewed as aiding competitive devaluation or
risk anti-trade steps from the US/China/both.
In other words, either halt any further steps toward more QE or negative
interest rates---or suffer the consequences.
That threat may not stop further devaluations but it will likely reduce
them.
If I am reading
this all correctly, this is a huge move.
It stops the trend to more QE/negative interest rates [and competitive
devaluation] in its tracks and shifts the onus of government efforts to
stimulate its economy back to fiscal policy---where it should have been all
along. More important, it means that
securities markets have lost a major psychological bulwark---the further easing
in monetary policy.
These
developments also assume that the US/Chinese powers-that-be likely acted on the
belief that the global slowdown is behind us.
Either that or it wasn’t the Japanese who figure out that all this QE
bulls**t doesn’t work, it was the US/China.
Why else would they limit their own ability to utilize levers of monetary
policy?
This doesn’t
mean, of course, that the global slowdown is behind us nor does it mean that the
process of unwinding asset mispricing and misallocation is about to begin; it
just means the process QEInfinity is over.
To be clear, much
of what I have said is just me speculating about motives and results; but it is
not idle speculation. Recent developments
certainly make my conclusions reasonable. However, I could be wrong about the Treasury’s
assumptions, motives and possible policy consequences. For the moment, I regard
the above as a thesis that needs to be proven.
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime. What
they have done is lead to asset mispricing and misallocation. Sooner or later,
the price will be paid for that. The longer it takes and the greater the
magnitude of QE, the more the pain.
The end game
from JP Morgan (medium):
(4) geopolitical
risks: about the only news this week was new US boots on the ground in Syria. The good news is that there were only a few new
boots. The bad news is that it still
more than there ought to be.
Nonetheless,
the risks from a step up of terrorists’ bombings, turmoil in the EU over
immigration and assimilation policies and adventurist polices by Russia, Iran
and North Korea all remain. There is a
decent chance of an explosive event stemming from one or more of the
aforementioned, though I have no idea just how big it could be or which one is
more likely to occur.
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week made a positive showing for the first time in a long time:
[a] the April German business climate index fell, but
consumer confidence rose and unemployment declined,
[b] first quarter UK GDP growth slowed; however,
Italian, French and EU first quarters were better than anticipated; first
quarter EU inflation was below projections,
[c] March Chinese industrial profits were quite
strong---if you believe it,
[d} Italian unemployment was below forecasts,
The relative consistency of the
positive EU data is noteworthy. As I indicated
above, I don’t think that we assume that Europe has turned around and is
heading out of the doldrums. However, I don’t
know how you could get a better first sign.
Clearly, this is something to which to pay close attention. That said, if the numbers are signaling
economic improvement, Draghi et al will soon be faced with the same dilemma as
the Fed, to wit, the transition from easy to normalized monetary policy and
with it all risks associated with tightening too fast [stymieing a nascent
recovery] or too slow [inflation].
Bottom line: a lot may be potentially changing. To be sure, the US data in aggregate
continues to point toward a recession. However,
the EU economy showed the first sign of life in months. And the Bank of Japan inaction may indicate
that peak QE and negative rates are behind us.
To be clear, neither of these possible changes to the economic landscape
should be taken seriously at this point.
They are simply an alert that transformations could be afoot. And remember, four weeks ago I thought that
there was a possibility that the US economy could be turning and that came to naught.
Subject to more
data, 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
fell; March new home sales were terrible; the February Case Shiller home price
index was in line,
(2)
consumer: month to date retail chain store sales were stronger
than the prior week; both the April consumer confidence and consumer sentiment
were below projections; jobless claims fell less than estimates,
(3)
industry: March durable goods orders were well below
forecasts; the April Chicago PMI was below expectations; the April Dallas Fed
manufacturing index came in below consensus, while the Richmond Fed’s index was
better than anticipated,
(4)
macroeconomic: the March US trade deficit was lower
than estimates; first quarter GDP was below projections; March personal income was higher than forecasts
while personal spending was below.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17773, S&P 2065) had their first rough week in last six. Volume on
Friday increased. Breadth was weak. The VIX continues to act as if it has made a bottom.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] within a short term uptrend {17692-18646}, [c] in an
intermediate term trading range {15842-18295} and [d] in a long term uptrend {5541-19413}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] below the lower boundary of its short term
uptrend for the second day {2106-2208}; if it remains there through the close
on Monday, it will reset to a trading range, [d] in an intermediate term
trading range {1867-2134} and [e] in a long term uptrend {830-2218}.
The long
Treasury performed a bit better this week.
But it is still in a congested range marked by a key Fibonacci level on
the downside and the upper boundary of its intermediate term trading range on
the upside. As long as it remains in
this area, it does not provide much informational value.
On Friday GLD (123)
broke above its recent high and is a mere 1.25 points away from the upper boundary
of its intermediate term trading range.
If that level is breached, 140 is the next resistance level,
Bottom
line: the bulls got their first taste of
cognitive dissonance in over six weeks. If the S&P negates its short term
uptrend, then this decline is apt to be more than just a pause that
refreshes. Still the Dow remains within
its short term uptrend and the breadth while weakened is not flashing
disaster. I am changing nothing in my
technical outlook at the moment. But
maintaining it could prove difficult next week.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17773)
finished this week about 42.9% above Fair Value (12432) while the S&P (2065)
closed 34.2% overvalued (1538). 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 numbers
were negative again this week which I believe lessens the probabilities of
improvement. On the other hand, the
international economic releases were surprisingly upbeat. However, one week of plus numbers is not
enough to remove this factor as a headwind to our own recovery.
Oil prices continued
to advance. While the stats currently don’t support the notion that
supply/demand is coming into balance, still stocks have a way of anticipating
change. So if the fundamentals in energy
are improving, then that would (1) at least begin to remove a negative [oil
company bankruptcies] hanging over the banks and (2) serve as a positive for
stock prices---if the current correlation between oil and equity prices continues
to hold. To be clear, I am not saying
that energy fundamentals have improved; but like so many other changes that may
potentially be occurring, this is a factor that must be watched.
In sum, our forecast
of recession appears to be unfolding, though improving energy fundamentals and
an EU economy could potentially be mitigating factors. Nonetheless, most Street forecasts for the
economy and corporate earnings are exceedingly optimistic; and stock valuations
are priced for perfection. Even if all
these forecasts are met (1) there remains little upside in stock prices and (2)
global central bankers are going to be faced with adjusting what has been a far
too aggressive expansion of monetary policy and (3) markets will sooner or
later be faced with the readjustment of asset pricing and misallocation.
And speaking of
central banks, the Bank of Japan’s decision not to go further down the QE road
may be the beginning of this process. I
am not saying that is occurring; I am saying that it could be and we need to be
alert to that development. Because, as I
noted above, if central banks start reversing QE, they will be one step closer
unwinding asset mispricing and misallocation; and that is not likely to be well
received by the market.
I continue to 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. 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 caused by
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 4/30/16 12432
1538
Close this week 17775
2065
Over Valuation vs. 4/30 Close
5% overvalued 13053 1614
10%
overvalued 13675 1691
15%
overvalued 14296 1768
20%
overvalued 14918 1845
25%
overvalued 15540 1922
30%
overvalued 16161 1999
35%
overvalued 16783 2076
40%
overvalued 17404 2153
45%
overvalued 18026 2230
Under Valuation vs. 4/30 Close
5%
undervalued 11810
1458
10%undervalued 11188 1384
15%undervalued 105678 1307
* 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.
