The Closing Bell
4/23/16
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 -1.25-+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 17529-18484
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 Uptrend 2080-2182
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 maybe providing a temporary upward bias to equity valuations (for at
least another week). The stats this week were again somewhat sparse
and again weighted to the negative: above
estimates: weekly mortgage applications, weekly jobless claims and March existing
home sales; below estimates: weekly purchase applications, the NAHB index, March
housing starts, month to date retail chain store sales, the April Philly Fed
index, the March Chicago Fed National Activity index, the April PMI
manufacturing index and the March leading economic indicators; in line with
estimates: none.
The primary
indicators were also negative: the March existing home sales (+), March new
home sales (-) and the March leading economic indicators (-). In the last 33 weeks, seven have been positive
to upbeat, twenty five negative and one neutral.
One final note
on that two week run of better stats out of the manufacturing sector---given
the last three weeks data, it appears to have been an apparition. Hence, my concern about jumping the gun on
our recession forecast is no more.
Similar to the
US, the international economic stats were few but negative--- continuing to act
as a headwind to our own economy.
The central
banks maintained their push to even easier monetary policy as the both the Bank
of Sweden and the ECB stepped up asset purchases. We should get more of the same next week as
both the Bank of Japan and the Fed have regular scheduled meetings.
In summary, the US
economic stats were negative while the international data remains depressing. Meanwhile, the central banks are doing their utmost
to create a paper shortage.
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:
[a] the Fed sent a scathing letter to JP Morgan pointing out
numerous unresolved risks in its financial statements,
[b] Deutschebank admitted to rigging the gold and silver
markets and to having E21 trillion notional value of derivatives in its portfolio,
[c] in a speech this week, George Soros outlined his
concerns about the financial strength of Chinese banks. Here is some more analysis (medium):
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. Two items that I think bear
mentioning:
[a] the
insolvency of the Central States pension fund and the likelihood of severe
reductions in benefits {I linked to this on Thursday}. One of the points in the aforementioned article
was that two individuals, ages 64 and 68, would have their monthly joint benefits
reduced from $7,000 to $4,000. Think
about that. $7,000 is a huge monthly payout
for two people that young---no wonder Central States has a problem. Regrettably, this is most probably not an
isolated incident. It is going to happen
again and again as these big defined benefit plans can’t meet their obligations
{reminder me, Janet, of the benefits of lower interest rates}. The ultimate consequence: lower consumer
spending. That ought to help spur
economic growth.
[b] the growing
influence of high frequency trading on the Market. Doug Kass has been complaining about this for
some time. The point here is that like
so many other financial ‘innovations’ {think securitized debt} this will also likely
come to an ignominious end and the Market repercussions will be painful.
(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 central
banks kept up their good work this week.
The Bank of Sweden stepped up bond buys and the ECB left rates unchanged
but increased their asset purchases.
ECB unleashes global
QE (medium and a must read):
And next week
should offer more of the same as both the Bank of Japan and the FOMC meet. Current expectations are [a] for more easing
from the BOJ {which were supported by a news release Friday suggesting a further
move into negative interest rate territory} as {i} it attempts to offset the decline
in economic activity resulting from the recent earthquakes and {ii} current
data continues to get worse and [b] more happy talk from the Fed about all the
reasons why it is not going to raise rates.
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.
(4) geopolitical
risks: there only a few minor incidents this week: Russia buzzing a couple of
US naval vessels, terrorists bombings in Israel and Afghanistan and the growing
discord between the US and Saudi Arabia over the 9/11 investigative documents.
Nonetheless,
the risks from a step up from 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. Like the US, the international economic stats
released this week were sparse and downbeat:
[a] German investor confidence rose despite the German
government’s downgrading of the country’s 2017 economic growth prospects,
[b] March UK retail sales fell more than anticipated,
[c] March Japanese trade figures deteriorated. Since China is one of their major trading
partners, that seems to argue against all the cheery economic news out of that country. I am not saying that it is impossible for
China’s economy to be improving at the same time that Japan’s trade numbers are
worsening. I am saying that the Chinese
lie a lot and this bit of anecdotal evidence supports that thesis.
As expected, OPEC could barely agree to disagree, though
the ‘potential production freeze’ propaganda machine just keeps on truckin’. Meanwhile, demand keeps falling making a
production freeze largely irrelevant.
In short, the data we got was not
encouraging.
Bottom line: the US data in aggregate continues to point
toward a recession. The global economy did
nothing to brighten the outlook. OPEC is doing everything possible to confuse
and confound the Markets and the central banks refuse to face the fact that
their policies have not worked and, indeed, are adding to the risks in the
global financial system.
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 applications rose but purchase
application were down; the April National Homebuilders index was below forecast,
March new home sales were terrible while existing home sales were better than
expected,
(2)
consumer: month to date retail chain store sales were much
weaker than the prior week; weekly jobless claims were better than projected,
(3)
industry: the April Philadelphia Fed manufacturing
index was a disaster; the March Chicago Fed National Activity index was below
consensus as was the April PMI manufacturing index,
(4)
macroeconomic: the March leading economic indicators
were below forecast.
The Market-Disciplined Investing
Technical
The indices
(DJIA 18003, S&P 2091) rose modestly on the week as the upward progress got
a little tougher. Volume on Friday increased but off of a very mediocre level
on the week. Breadth was been good but
not great. The VIX appears to have found
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 {17529-18484}, [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 uptrend {2080-2102},
[d] in an intermediate term trading range {1867-2134} and [e] in a long term
uptrend {800-2161}.
The long
Treasury ran into some congestion this week, voiding a very short term uptrend. The bad news is that if it continues to fall,
it could be signaling either higher inflation or a tighter Fed (say, what?). The good news it held above a key Fibonacci level
and remained within its short term uptrend as well as above its 100 day moving
average.
GLD is still struggling
to consolidate recent gains. Failure to
do so could also suggest higher interest rates.
Bottom
line: the indices plodded forward this
week, though I have warned that they were in heavily congested territory and
not to expect sustained upward momentum.
However, my assumption remains that they challenge their all-time highs but
fail to push above them.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18003)
finished this week about 44.8% above Fair Value (12432) while the S&P (2091)
closed 35.9% 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 this week. Further, the temporary
bright spot in recent data---manufacturing stats---proved to be just that,
temporary. In addition, the
international economic releases remain quite discouraging.
As I noted
above, the OPEC production freeze meeting was a flop. But that didn’t stop oil prices from continuing
to advance. This could be an indication
that real supply/demand is coming into balance, though the stats currently don’t
support that notion. 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.
In sum, our forecast
of recession appears to be unfolding. That would render most Street forecasts
for the economy, corporate earnings and stock valuations too high.
Thankfully the Fed
was nowhere to be seen this week; but other central banks were busy little
beavers as both the Bank of Sweden and the ECB increased QE. Unfortunately, these efforts continue to
produce zero positive economic results.
Equally unfortunate, they have generated negative results (just ask
those aforementioned pensioners) which the bankers, in their infinite wisdom,
have chosen to ignore.
As you know,
earnings season is upon us; and results to date have been pretty much as
expected---which means down. Investors
are finding salvation in the rationale that the profits are at or near their bottom
and that by year end they will again be in an upswing. Far be it from me to argue with the Street
sages (but, of course, I will), however, I have tried to document their continually
over optimistic forecasts (note: they get paid to create reasons for you to buy
stocks) versus what actually was reported.
In short, this could be a positive but not one on which to place a big
bet.
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 18003
2091
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.
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