The Closing Bell
8/13/16
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 17545-19281
Intermediate Term Uptrend 11312-24139
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 2058-2297
Intermediate
Term Uptrend 1917-2519
Long Term Uptrend 862-2400
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
dataflow this week was negative again: above
estimates: weekly mortgage and purchase application, month to date retail chain
store sales and June wholesale and business inventories and sales; below
estimates: July retail sales, weekly jobless claims, August consumer sentiment,
July PPI, second quarter nonfarm productivity and unit labor costs and the July
US budget deficit; in line with estimates: July small business optimism index and
July import/export prices.
The primary
indicators were also disappointing: July retail sales (-) and second quarter
nonfarm productivity (-). While not primary indicators, the terrible PPI (deflation?)
and budget deficit numbers (how can tax receipts be down when everything is
awesome?) are worrisome. With another
really poor week for stats, it is looking more like that four week stretch of
upbeat numbers a while back was more of an outlier than a sign that the economy
was improving. I am not making that call
yet; but clearly I feel more comfortable with our current forecast. The score is now: in the last 47 weeks, thirteen
have been positive to upbeat, thirty-one negative and three neutral.
Overseas, the data
wasn’t much better with China turning in some really lousy numbers. And don’t forget, these guys lie a lot; so
there is no telling how really bad things are.
Meanwhile, the
developing problems in the Italian, German, Portuguese and Greek banking
systems remain a question mark. The only
(supposed) bright spot was the results of the latest EU banking ‘stress’ test,
released a couple of weeks ago. However,
those findings were challenged by a German economic research institute report
this week that indicated that Deutschebank was basically insolvent. Plus the Bank of Italy announced that its
banking system’s nonperforming loans grew an additional 1% in July.
The global
central bankers joined the Fed’s campaign to confuse the Markets sufficiently
to avoid having to admit QEInfinity has and will accomplish nothing. Tuesday
the Bank of Japan issued a more dovish statement than its prior one. The Bank of China also sounded dovish and
then reversed itself the next day. So
far they have been successful.
However, the
cognitive dissonance on QEInfinity’s value increased this week when the Bank of
England announced that it was having problems implementing its brand spanking
new bond buying program because no one would sell to it. All that said, investors continue to be mesmerized
by all the central bankers’ esoteric bullsh*t.
Until that ends, belief in central bank wisdom, Santa Claus and the
Easter bunny will apparently go unchallenged.
In summary, this
week’s US stats were very poor as was the international data. Central banks appear to have adopted our Fed’s
policy of doing nothing, dazzling investors with their foot work and praying
for a miracle exit from QE. Meanwhile,
lest we forget, 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 flashing
warning light for change is now yellow.
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 got
more bad news this week: [a] Italian bank bad loans grew another 1% in July and
[b] a German economic research institute found that Deutschebank had a capital
shortfall greater than its market capitalization.
In addition, Warren Buffett eliminated his entire credit
default swap position. I have harped on
the, as yet unquantifiable risk, posed by the derivative positions on bank
balance sheets. Mr. Buffett’s actions
seem to suggest that he too is worried about the potential hazard that they
represent.
As you know, I have
been giving the US banks and regulators the benefit of the doubt when it comes
to their balance sheet repair efforts.
However, this week several of the major US banks have asked the Fed for
an extension of the implementation of the Volcker Rule [requiring them to exit
private investments]. This is on top of
three extensions already granted by the Fed.
The bottom line here is that the Fed and the banks can yak all they want
about improved balance sheets, but clearly if the banks haven’t solved their
nonperforming loan problems in seven years, those balance sheets are not nearly
a sound as we have been led to believe.
[must read]
Staying with
potential US banking problems, it appears that US farmers are starting to have
credit issues (medium):
Finally, under
the category of ‘history repeats itself, but we never learn’, US life insurers
are now in a bind due to their ownership of energy related bonds that are now
nonperforming and the regulators are considering alleviating the capital
requirements as they relate to those nonperforming assets (medium):
(2) fiscal/regulatory
policy. What do you say when faced with
the worse choice for a President in your life time? ‘May the Lord bless you and keep you; may ………’ I despair with what further abuse our economy
will have to endure for another four years.
Instead of worrying about a stagnating economy, declining real wages,
trillions spent on an endless war [see the July budget deficit], our candidates
are too busy shooting themselves in the foot to even address these issues
effectively. And that group of morons in
congress, they can’t even get together on zika funding because of their
inability to compromise. My first hope
is that I am dead wrong and that somehow, some way, this clown show gets
serious. If that fails, my second hope is
that the government will somehow remain split and gridlock prevails until 2020.
The lies that
politicians are telling us (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.
Two weeks ago,
I wistfully contemplated a potentially less dovish stance to monetary policy by
the global central bankers. This week
that notion has changed to ‘I have no idea what these guys are doing’ because
[a] on Tuesday the Bank’s of China and Japan trumpeted their ongoing bond
buying programs; then on Wednesday, the Bank of China walked back its dovish
statement and [b] remember that I had already made a point of the Bank of Japan
mimicking our Fed with its ever popular ‘on the one hand, on the other hand’
routine; well Tuesday was yet another flip flop.
So it appears
that most central banks are reaching the same conclusion as our own
Fed---QEInfinity hasn’t worked, they believe that admitting it would undermine their
credibility and so the only alternative is to obfuscate. The notion of central bank infallibility was
also dealt a blow this week when the Bank of England lamented that it couldn’t
find enough sellers to fully implement its new bond buying policy. [must read]
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.
The declining
relevance of the Fed (medium):
The Fed’s
inability to match their model with reality (medium and a must read):
Déjà vu all
over again (short):
(4) geopolitical
risks: Brexit, Turkey, war in the middle east, global terrorism, Chinese
aggression in the South China Sea and now Ukraine [again] are on ‘simmer’. While each has the potential to develop into
something bigger, none of them have risen to the level of crisis. Barring some dramatic development or the
appearance of a general negative narrative to which they could contribute, this
risk will remain of lesser importance.
(5)
economic difficulties in Europe and around the globe. The international economic stats, while in
short supply this week, were was tilted to the negative side.
[a] June UK industrial production was up, in line;
June German industrial production and first quarter GDP rose more than estimates;
July UK existing home sales fell,; first quarter Italian GDP was below
forecasts; the second quarter flash EU GDP was in line,
[b] July
Chinese retail sales, industrial production, fixed investment, imports and
exports declined much more than anticipated plus consumer and industrial
inflation were below expectations.
So the trend in international stats
continues to point to a weakening global economy. Add the mounting banking problems in Europe
and little support for the US economy can be expected from abroad.
Bottom line: the US economy remains weak though there is a diminishing
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: weekly mortgage and purchase applications were
up,
(2)
consumer: July retail sales were a disappointment; month
to date retail chain store sales were better than the prior week; weekly
jobless claims fell less than anticipated; August consumer sentiment was below forecasts,
(3)
industry: June wholesale inventories and sales were
better than projected as were June business inventories and sales; the July
small business optimism index was in line,
(4)
macroeconomic: second quarter nonfarm productivity and
unit labor costs were really bad; July import and export prices were mixed; the
July budget deficit soared; July PPI plunged.
The
Market-Disciplined Investing
Technical
On Friday, the
indices (DJIA 18576 S&P 2184) once again couldn’t generate any follow
through off of Thursday’s move up.
Volume fell and breadth weakened slightly. The VIX was down 1.25%, finishing below its
100 day moving average, within a short term downtrend but very close to the
lower boundary of its intermediate term trading range (support). Given the trouble the VIX had in taking out
its short term trading range, it could have even more difficulty with the
intermediate term. That said, the reset
to a short term downtrend has to be viewed as a plus for stocks.
The Dow ended
[a] above rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term uptrend {17545-19281}, [c]
in an intermediate term uptrend {11312-24139} 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 {2058-2297}, [d]
in an intermediate uptrend {1917-2519} and [e] in a long term uptrend {862-2400}.
The long
Treasury rose, ending above its 100 day moving average and well within very
short term, short term, intermediate term and long term uptrends. On Friday, it tried to break to the upside out
of that pennant formation on which I have been focused but failed. A successful challenge would mean lower
interest rates, suggesting a weaker economy.
GLD fell, ending
above its 100 day moving average and within short term and intermediate term
uptrends. However, this week it failed
at its second try to surmount a key Fibonacci level, then negated a very short
term uptrend. That has me concerned
about our GDX holding.
Bottom line: forget
the economic data, forget the confusion being spread by the central banks,
forget volume and breadth, forget everything.
Stocks want to go up, so they are.
That said, I still think that the pin action in the VIX and the bond,
gold, oil and currency markets are indicating that something is amiss. Be careful.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18576)
finished this week about 48.0% above Fair Value (12543) while the S&P (2184)
closed 40.9% 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---continuing the reversal of that four weeks period
of improved data. To be sure, we can’t
ignore those four weeks. So I leave open
the possibility that the economy is stabilizing---though the odds of that
occurring are slipping.
Overseas, it was
the same old song---more poor stats; and we haven’t yet seen any of the
potential economic consequences of the Brexit or the banking problems in
Germany and Italy. ‘Muddle through’
continues to be our scenario for the global economy; but that is increasingly
in question.
What concerns me
about all this 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 suggests
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/global central
banks remaining accommodative. On that
score, the central banks are exhibiting some troublesome behavior. The Banks of both China and Japan have sent
conflicting messages over the last two weeks---a strategy that our own Fed has
perfected. In the short run, that may help
investors rationalize a goldilocks scenario but over the long term, waffling
has never proven an effective policy tool.
Also clouding the monetary ‘confidence’ policy picture is the UK fixed
income Market’s muted reception to the new Bank of England bond buying
program.
I have no idea how
long this central bank shadow boxing around any firm policy moves can last. Clearly, it has worked magnificently to
date. But sometime either unwinding
QEInfinity or QEInfinity’ lack of success will become a Market issue. Stocks may be 1%, 5%, 10% higher when that
happens; but it seems very likely to occur.
From my point of view, I am already getting nosebleed from the lofty
valuation levels; so making the ‘how much higher can the Market go’ bet, seems
a foolish undertaking.
As you know, I
believe that sooner or later, the price will be paid for flagrant mispricing
and misallocation of assets.
‘There is no
alternative’ is BS (medium):
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 8/31/16 12574
1554
Close this week 18576 2184
Over Valuation vs. 8/31 Close
5% overvalued 13202 1631
10%
overvalued 13831 1709
15%
overvalued 14460 1787
20%
overvalued 15088 1864
25%
overvalued 15717 1942
30%
overvalued 16346 2020
35%
overvalued 16974 2097
40%
overvalued 17603 2175
45%
overvalued 18232 2253
50%
overvalued 18856 2331
Under Valuation vs. 8/31 Close
5%
undervalued 11945
1476
10%undervalued 11316 1398
15%undervalued 10687 1320
* 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 74hard way.
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