The Closing Bell
7/30/16
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 17403-19149
Intermediate Term Uptrend 11277-24107
Long Term Uptrend 5541-19431
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2039-2278
Intermediate
Term Uptrend 1907-2509
Long Term Uptrend 862-2246
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, though that could be
changing. The dataflow this week returned to the
negative column: above estimates: June new
homes sales, month to date retail chain store sales, July consumer confidence,
the July Chicago PMI and the Dallas and Richmond Fed’s July manufacturing
indices; below estimates: the May Case Shiller home price index, June pending
home sales, weekly mortgage and purchase applications, weekly jobless claims, the
July Markit flash services PMI, the July Kansas City manufacturing index, June
durable goods orders, second quarter GDP and price deflator and the June trade
deficit; in line with estimates: none.
The primary
indicators were also disappointing: June new home sales (+), June durable goods
orders (-) and second quarter GDP (-). With
such a marked turn in the numbers, the question is which is the outlier---this
week’s return to the long term negative trend or the prior four upbeat weeks
bounce, indicating a stabilization in the economy? The answer is that I don’t know; but you see
the reason I have held off making a change in our forecast. It also leaves open the chance that this year
will be a repeat of the prior two---a lousy first quarter, a rebound in the
second quarter and then a return to mixed to negative numbers for the rest of
the year.
The score is
now: in the last 45 weeks, thirteen have been positive to upbeat, thirty
negative and two neutral.
While sparse, the
numbers from abroad improved slightly.
Much more of this is needed to provide any proof that the global economy
is getting better.
Meanwhile, the
developing problems in the Italian, German, Portuguese and Greek banking
systems remain in question. Of course,
you wouldn’t know it by reading the results of the latest EU banking ‘stress’
test that were released last night. On the
plus side, there were a number of banks, particularly the British banks, which
have made definite progress in building capital and getting nonperforming loans
under control. That said, in performing
the ‘stress’ test the EU banking authorities didn’t issue pass or fail ratings,
excluded Greek and Portuguese banks, presumably because they are in such bad
shape and there were no penalties for being lousy or near insolvent.
As expected the
Italian banks were among the weakest banks with one of them rated as the worst
of all banks measured. But who
cares. This ‘stress’ test was like my
grandson’s soccer league. There are no
winners or losers and everyone gets trophy no matter how sh*tty a player he is. So I guess there is no banking crisis; there
is just a bunch of bankers walking around with a stick of dynamite stuck up their
ass waiting for that unexpected kick.
The FOMC met
this week; and while it acknowledged that the economy was improving, it still
did nothing by way of monetary tightening.
To be fair, it is likely that even if the committee was convinced that
it was time to raise rates, they likely wouldn’t due to the potential impact on
the election. That said, I don’t believe
the elections had had jack to do with the decision. The only thing that matters is asset prices.
In addition, the
ECB left rates unchanged, which is to say, quite low. And Bank of Japan after doing three days of
the green apple two step ended up leaving rates unchanged and barely increasing
its asset buyback program. I don’t know
if this means that the Bernank was unsuccessful in pushing the ‘helicopter’
money strategy onto the Japanese or if the Japanese rejected it or if he
actually recommended restraint. It would
be interesting to know because it could have implications here.
In short, global
QE seems to be, at least temporarily, stalled.
In summary, this
week’s US stats turned negative again; while the international data was
marginally improved. Central banks have
thankfully put monetary expansion on hold for the moment. However, we still haven’t even seen the
potential fallout from Brexit and/or the mounting EU banking difficulties. For the moment, I am not altering our outlook
though the red warning light is flashing.
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. Deutschebank and the Italian banking system have
seriously impaired balance sheets notwithstanding the happy face being put on
by EU banking officials. Conditions are
so bad in the Greek and Portuguese banks that those same authorities wouldn’t
even release their results in the latest ‘stress’ test. Clearly, the EU strategy is to pray that their
banking system will ‘muddle through’; and it may. But it still poses the risk of a Lehman
Brothers type crisis.
(2) fiscal/regulatory
policy.
Martin
Feldstein on the deficit (medium):
David Stockman
on fiscal policy (medium and a must read):
Alan Greenspan
on the coming stagflation (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 G20 met
this week and mumbled through its analysis and recommendations for stimulating
global growth.
The ECB met and
left policy unchanged; but promised that more monetary ease was coming.
The FOMC met
and, aside from stating the obvious, did nothing.
In Japan, government
took a page out of our Fed’s playbook, leaking multiple versions of new
improved fiscal policies to spur domestic growth and then presented an
aggressive stimulus program but with insufficient details on
implementation. That turned investor
attention to the Bank of Japan, who it was hoped would provide the means [i.e.
abundant QE] for the execution of the as yet unclear fiscal measures. Well, that didn’t work out so well because
the BOJ did very little---leaving everyone guessing about what will really
happen. Of course, since the Japanese copied
the Fed in their presentation, it is not surprising that they got a similar
result---confusion.
It may just be
coincidence but there is a definite pattern to the above; that is, no central
bank did anything of substance to further the cause of QEInfinity. Whether that means that they all think the
global economy has improved to the point no further monetary stimulus is
necessary or that they have all figured out that QEInfinity hasn’t worked and
more of the same won’t either or that it is just a coincidence is anyone’s
guess at this point.
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime; so their absence will do little
harm. 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: ‘Brexit vote proved a nonevent,
the Middle East quagmire is, at the moment, just white noise while terrorism
has gained center stage. Of course, the
latter can go on forever with little impact on the US or global economy. Their risk is largely psychological and they only
have economic or Market influence if they add fuel to a larger negative
narrative---like the vanishing anchovies off the Peruvian coast back in the mid-70’s
inflation crisis. And as we all know, at
the moment, there is no negative narrative anywhere in sight---at least that
anyone is paying attention to.
That said, lurking in the weeds is the
potential banking crises developing in Germany and Italy (and now Portugal). Plus
the Catalan parliament voted to secede from Spain, which only adds to the
potential risk of social/political and financial instability in the EU. Of
course, the willingness of the central banks to continue paper over bank
insolvencies is without limit and the willingness of the Markets to ignore the
obvious has been story line for the last eighteen months. So this too may only matter in the context of
the aforementioned as yet unappreciated larger negative narrative.’
(5)
economic difficulties in Europe and around the globe. The international economic stats, while meager
this week, were tilted to the positive side.
[a] second quarter UK GDP was stronger than projected,
but July retail sales were quite weak; July Italian business and consumer
confidence rose while July German business sentiment declined less than
anticipated; July German and Spanish unemployment fell while Italian
unemployment rose; second quarter French GDP was disappointing; July EU flash
inflation advanced in line,
[b] June
Japanese exports and imports fell markedly though not as much as estimated; the
July Japanese manufacturing PMI rose slightly but remained in negative
territory.
While I will take any improvement in a seriously
negative trend, this week’s turnaround is hardly impressive. Certainly, this upbeat blip in an otherwise
cheerless trend toward a weakening global economy is no reason to question its
overall direction. Add the mounting
banking problems in Europe and little support for the US economy can be
expected from abroad.
You must read
this stunning self critique by the IMF of its failed policy in Greece. The question is will it have any effect on
the next crisis?
Bottom line: the US economy remains weak though there is a chance
that it could be stabilizing. However, there
is little aid from the global economy; and the potential consequences of the Brexit
and the mounting EU banking crisis (?) could make things worse. Meanwhile, our Fed remains confused,
inconsistent and seemingly oblivious to data.
Central bank credibility is a growing issue; though to date, investors
don’t seem to care.
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: June new home sales were strong, but pending
home sales were weak; the May Case Shiller home price index was disappointing; weekly
mortgage and purchase applications were down,
(2)
consumer: month to date retail chain store sales were better
than the prior week; July consumer confidence was up more than anticipated
while consumer sentiment was up less; weekly jobless claims rose more than expected,
(3)
industry: July durable goods orders were much worse
than estimates; the July Dallas and Richmond Fed’s manufacturing indices were
better than consensus while the Kansas City index was worse; the July Chicago
PMI was higher than projected; the July Markit flash services PMI was less than
forecast,
(4)
macroeconomic: second quarter GDP was one half of
expectations while the price deflator was much higher; the June US trade
deficit was larger than projected.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 18432 S&P 2173) closed near the flat line again yesterday (Dow down,
S&P up). Volume rose and breadth
continued weak. The VIX plunged 6.7%,
closing back below the lower boundary of its former short term trading range
(having successfully challenged, then regaining it the day following the reset,
staying there four days and now finishing well below). I remain on the fence on this directional
call.
The Dow closed
[a] above rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term uptrend {17403-19149}, [c]
in an intermediate term uptrend {11277-24107} and [d] in a long term uptrend
{5541-19431}.
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
{2039-2278}, [d] in an intermediate uptrend {1907-2509} and [e] in a long term
uptrend {862-2246}.
The long
Treasury rose nicely, ending above its 100 day moving average and well within
very short term, short term, intermediate term and long term uptrends.
GLD jumped 1%,
ending above its 100 day moving average and within very short term, short term
and intermediate term uptrends.
Bottom
line: ‘the equity Market keeps sleeping through a heavy calendar economic
data, earnings reports and central bank meetings---although to be fair there
wasn’t much new in any of this. This pin
action is encouraging in that the current sideways consolidation after a ten
percent up move suggests that the bulls are still in control.’
But I am uneasy over
the simultaneous volatility in the VIX and the bond, gold, oil and currency
markets. Something seems amiss. Be careful.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18432)
finished this week about 46.9% above Fair Value (12543) while the S&P (2173)
closed 40.2% overvalued (1550). 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 economic
numbers were quite negative---a clear reversal of the prior four weeks’ data. To be sure, we can’t ignore those four weeks;
so I leave open the possibility that the economy is stabilizing. However, I can’t ignore the US growth pattern
of the last two years [down Q1, rebound in Q2, more weakness in Q3/Q4]. What we need is more information and until we
receive a sustained directional bias to the contrary, our forecast of recession
stands.
Overseas, we saw
a slight improvement in the economic numbers.
That said, we are yet to see any consequences of (1) the Brexit. As you know, I am an optimist on this point;
but I still expect some weakness, (2) the banking problems in Germany and
Italy; (3) the Catalan secession vote. I
am making no predictions here; but the best thing that could happen is nothing.
What concerns me
is that, (1) most Street forecasts for the moment are more optimistic regarding
the economy and corporate earnings [down 3% in the second quarter at the latest
count] than either the numbers imply or our own outlook 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.
That said, the
Market to date has been inversely correlated to the economy because of the
heavy influence of monetary policy [weak economy = easy Fed = rising stock
prices]. So you would think that a
recession would be good for the Market.
The obvious problem with this rationale is that by extension, if we got
a depression, stock prices would soar---which defies logic I don’t care how
easy the Fed may be. On the other hand,
by implication, an improving economy would suggest a decline in stock prices
especially when they are already in nosebleed territory.
So as I see it,
stocks are at or near a lose/lose position.
If the economy is in fact going into recession, sooner or later the deterioration
in corporate income, dividends and balance sheets will overwhelm the present
positive psychological predisposition toward an irresponsibly easy monetary
policy. If the economy does improve,
then sooner or later the fixed income market will force the Fed to tighten and
the QE magic will be gone. Or it may be
that some exogenous event hits investors between the eyes and they suddenly
recognize Fed policy for the sham that it is.
In any case, at the moment, investor
psychology seems inextricably tied to its confidence in the Fed remaining
accommodative. On that score, the
central banks did little to build investor confidence this week: the ECB did
nothing but promised more; the Fed did nothing and the Japanese put on their
best Kabuki dance, promising much and delivering little. Plus the bankers, the white washed EU ‘stress’
test notwithstanding, are faced with some potentially harrowing events: ECB
bank illiquidity, the fallout from Brexit and the whatever results from the
Catalan secession.
As you know, I
believe that sooner or later, the price will be paid for flagrant mispricing
and misallocation of assets.
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 Brexit.
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; an EU banking crisis [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.
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 7/31/16 12543
1550
Close this week 18432 2173
Over Valuation vs. 7/31 Close
5% overvalued 13170 1627
10%
overvalued 13797 1705
15%
overvalued 14424 1782
20%
overvalued 15051 1860
25%
overvalued 15678 1937
30%
overvalued 16305 2015
35%
overvalued 16933 2092
40%
overvalued 17560 2170
45%
overvalued 18187 2247
50%
overvalued 18814 2325
Under Valuation vs. 7/31 Close
5%
undervalued 11915
1472
10%undervalued 11288 1395
15%undervalued 10661 1317
* 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.
