The Closing Bell
6/11/16
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 17498-18726
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 (?) 2077-2300
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. In a
very slow data week the stats were slightly negative: above estimates: weekly
mortgage and purchase applications, weekly jobless claims and wholesale inventories
and sales; below estimates: month to date retail chain store sales, April consumer
credit, initial June consumer sentiment and the May US budget deficit; in line
with estimates: first quarter productivity.
Plus, there were
no primary indicators this week, making this a very dull week indeed.
Even though the
numbers on balance were downbeat, due the paucity of data, I am leaving open
the question of whether or not the US economy is starting to stabilize. At the moment, I believe the odds are low
that this is occurring; but I leave it as a possibility. The score is now: in the last 39 weeks, nine
have been positive to upbeat, twenty eight negative and two neutral.
The numbers from
abroad were ever so slightly upbeat, which is clearly better than being
negative. However, the international stats
have been bad enough, long enough that a mixed to modestly positive week barely
warrants notice and is certainly no reason to be questioning the overall trend.
Yellen spoke on
Monday and reversed the hawkish comments of other FOMC members from the prior
week, pushing the probability of a June/July rate hike to very low levels. Aside by being confusing as hell, it also lends
credence to the notion that these guys have no idea what they are doing. At the very least, it shows that their economic
forecasting ability is only slightly better than my two year old granddaughter.
I raised the
question last week: ‘was the jobless number a fluke or will it turn out to be
one of those defining moments when investors suddenly realize that the Fed has
been, is and will forever be, full of s**t.’ Methinks that we are a step closer
to the answer.
Supporting that
thesis, this week (1) Soros slammed Fed policy and the extreme asset mispricing
and misallocation that has accompanied it, (2) the Japanese opposition demanded
that the BOJ’s negative interest rate policy be reversed and Japan’s largest
bank withdrew as a primary dealer in government bonds and (3) Deutsche Bank
hammered the ECB for it ‘whatever it takes’ monetary policy. Is this the beginning of the end of central
bank credibility?
Finally, on Friday,
a British poll showed that majority of voters favor a Brexit---which has been
one of the potential geopolitical problems that has languished in the
background. I say languished because all
the polls until Friday indicated that the British electorate wanted to remain
in the EU. It now appears that this
issue has moved above the fold; and with the vote coming very soon, it will
likely stay there. I have tried to
present a balanced view of the likely consequences. But most of the headlines have been made by
the doomsayers. However, the bottom line
is that we all likely have no clue.
In summary, this
week’s US data did little to allay my concern about a slowing economy. Nor did the international data numbers. The big issue remains is the Fed at the
beginning of a growing credibility gap?
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. Another banking scandal in the EU (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. I expect little to occur on this
factor as the US moves into the presidential campaigning season. On the other hand, who knows what cockamamie
scheme we may be subjected to as our politicians promise the moon to buy votes.
(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.
Central banks
continue to be the objective of all things economic and investment. In the US, Yellen did what is apparently a
180 by mewing dovishly in a Monday speech.
After the parade of Fed chiefs parroting a hawkish line the prior week,
this dramatic turnaround likely reflects the shock coming from the jobs report last
Friday. Either that or she is setting
the Market up for one of the great trick f**ks in Fed history [i.e. it raises
rates in June].
In any case,
after having been joyous over the aforementioned Fed heads advocating rising rates due to an improving
economy, economists and investors alike were equally jubilant over Yellen’s
suggesting that there would be no rate increase due to a softening
economy. So it would appear that no one really
cares about what is occurring in the real economy; they only care about what
the Fed has to say about it.
Yellen isn’t
following her own favorite indicator (medium):
So at the
moment, the Fed seems bulletproof no matter how clear the indication that it
hasn’t a clue what is happening in the real world. Somewhere out there, this lack of logic will
likely overwhelm the current euphoria.
Could it be
happening now? As I noted above, this
week the central banks of the US, Japan and Europe were all subject to some
pretty tough criticism from respected sources.
Suggesting that central bank credibility may be on the decline would be
talking my book. But pointing out the
appearance of some cognitive dissonance from reliable sources is just stating
the facts. We await the consequences.
Banks rebel
against negative interest rates (medium):
Ed Yardini on
failed monetary policy (medium):
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime; so its absence will do little
harm. What it has 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: news this week was [a] the US accusing North Korea of restarting a
plutonium production plant and [b] the rapidly approaching Brexit vote. Much has been written about the possible
consequences of a negative vote. Whether
or not it proves as disastrous long term as the doomsayers predict, short term,
a Brexit vote likely will prove upsetting---as indicated by Friday’s sell off
following the release of a poll showing a majority of those polled favoring a
departure from the EU.
The costs
versus the benefits of Brexit (medium):
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 turned in a
slightly upbeat week:
[a] EU first quarter GDP was a bit better than
expected; April German industrial output was much better than anticipated
though industrial orders were worse: April UK industrial output was above
forecasts,
[b] first quarter Japanese GDP growth was revised up
from the original estimate; but May machine orders declined 11%,
[c] May Chinese trade data continued to deteriorate, while
retail sales were above consensus,
[d] the ECB began its corporate bond buying program; the
World Bank lowered its 2016 and 2017 global economic growth expectations.
The trend in poor global data went
flat this week, though that hardly shines as a hope for better things to come. Still there was a single one upbeat week
recently which raises the question, could one up and one flat week of stats be
a sign of a turn. At the moment, I think
not. Indeed, I believe the more
important question is, is the global economy sufficiently weak to keep downward
pressure on the US economy?
Bottom line: the US economy remains weak though there is an
outside chance that it could be stabilizing.
At this early stage, we can’t know.
In addition, there is little promise that the global economy is growing;
so no help there. Meanwhile, the Fed is
back doing its best impression of Alfred Hitchcock while the central banks of
Europe and Japan are starting to get some serious pushback on their total
ineffective QEInfinity programs,
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 were
up,
(2)
consumer: month to date retail chain store sales were weaker
than the prior week; April consumer credit grew much less than estimates;
weekly jobless claims were lower than forecast; the initial June consumer
sentiment index was slightly below projections,
(3)
industry: wholesale inventories and sales were better
than anticipated,
(4)
macroeconomic: first
quarter US productivity fell but was in line; unit labor costs rose more than expected;
the year to date US budget deficit is up 12.5% due to increased social spending
and lower corporate tax receipts.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17865, S&P 2096) had a good week, if you don’t count Friday; but
alas, you do. Darn. Volume on Friday increased. Breadth weakened. The VIX was up 16%, finishing right on its
100 day moving average. If it
successfully challenges this resistance line, it would not be good for
stocks. On the other hand, if it bounces
back down, it would indicate that the bulls are still in firm control.
The Dow closed
[a] above its rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term trading range {17498-18726},
[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 rising 100 day moving average, now support, [b] above
its 200 day moving average, now support, [c] within a short term uptrend {2082-2305}; however, Friday it was pounded back below the
upper boundary of the short term trading range that reset on Thursday’s
close. So there is now a question as to
the validity of that successful challenge.
Next week’s pin action will likely point to the true trend, [d] in an
intermediate term trading range {1867-2134} and [e] in a long term uptrend {830-2218}.
The long
Treasury was up again on heavy volume on Friday, closing above the upper boundary
of its intermediate term trading range.
If it remains there through the close next Tuesday, the intermediate
trend will reset to up. That would
indicate the bond guys believe pretty strongly that either the economy is
weakening or that TLT has suddenly become a safe haven. Either way, the implications are for some unpleasant
news ahead.
GLD was up of
Friday. It has clearly been performing
better of late. It is now well above the
lower boundary of its short term trading range and its 100 day moving average. However, it is still well below the upper boundary
of its short term trading range. So the
best that can be said is that GLD is solidly within a trading range.
Bottom
line: the bulls got a serious challenge
on Friday as the S&P reversed itself strongly and pushed well below the
upper boundary of the short term trading range which it had completed a
successful challenge of on Thursday. It
is not unusual for this kind of thing to happen. The problem is that it confuses the direction
of the underlying trend. In other words,
I can’t say whether the short term trading was successfully breached and Friday
was just a temporary trade below that level or the upside break itself was a
head fake. We will just have to wait
further developments next week.
The TLT may be
trying to give us a hint on what is going on the stock market. It is now challenging the upper boundary of
its intermediate term trading range, suggesting that either the US economy is
weakening or there is trouble developing overseas or both.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17865)
finished this week about 42.7% above Fair Value (12512) while the S&P (2096)
closed 35.5% overvalued (1547). 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.
This week’s US and
global economic numbers did little to influence our or likely anyone else’s
outlook. So I am sticking with our forecast
of recession.
What concerns me
is that, (1) most Street forecasts for the moment are more optimistic regarding
the economy and corporate earnings than our own but (2) even if all those
forecasts prove correct, our Valuation Model clearly indicates that stocks are
overvalued on even the positive economic scenario and (3) that raises questions
of what happens to valuations when reality sets in.
Perhaps the
biggest issue this week is recent developments that could impact central bank
credibility. In the US, the Fed ended up
with egg on its face after the disappointing
jobs number and then Yellen nixing what had become the operational Street
scenario, to wit, a June rate hike. So
far that hasn’t seemed to shake US investors’ confidence. However, the subsequent events described
above taking place in Japan and Europe have to have, at least some investors,
asking the same questions as the largest Japanese bank, the Japanese opposition
and Deutsche Bank.
At some point,
investors are going to realize that the Fed and its foreign cohorts have
screwed up the transition from extremely accommodative and normalized monetary
policy just like they have every other single time throughout history. When that happens, I believe that the cash
generated by following our Price Discipline will be welcome.
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. Near
term that could be influenced by whether or not the employment data was a fluke
and how the Market interprets the outcome.
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 [which may be occurring now];
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.
Comments
from Richard Fisher (medium and a must read):
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 6/30/16 12512
1547
Close this week 17865
2096
Over Valuation vs. 6/30 Close
5% overvalued 13137 1624
10%
overvalued 13763 1701
15%
overvalued 14388 1779
20%
overvalued 15014 1856
25%
overvalued 15640 1933
30%
overvalued 16265 2004
35%
overvalued 16891 2088
40%
overvalued 17516 2165
45%
overvalued 18142 2243
Under Valuation vs. 6/30 Close
5%
undervalued 11886
1469
10%undervalued 11260 1392
15%undervalued 10635 1314
* 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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