The Averages (27960,
3225) got carpet bombed on heavy volume yesterday.Both ended below the lower boundaries of
their very short term uptrends; if they remain there through the closetoday,
those trends will be negated.The Dow also
finished below its prior low and its 100 DMA (now support; if it remains there
through the close on Wednesday, it will revert to resistance).
Clearly, upside
momentum has been lost.But keep in mind
that the broken uptrends were very short term, hardly a reason to get major
league beared up.In addition, they both
experienced huge gap down opens which, as you know, I believe have to be
filled.So, to date, nothing really bad
has occurred.Supporting my initial technical
assumption following a breakdown like we just had is that a period of consolidation
is ahead.
True, the suddenness
and ferocity of the reversal in equity prices plus the fact that for the last two
months, the bond, gold and dollar markets have been aggressively pointing to something
amiss in Mudville, suggests that there is a chance that there could be more at
work here than just a technical selloff.While their message has been quite powerful, the Averages are going to
have to begin breaking major uptrends before it is proven correct.
Yesterday’s stats
were mixed.The February Dallas
manufacturing index was quite disappointing while the January Chicago Fed
national activity index was poor but not as much as expected.
Overseas, the February
German business climate index came slightly better than anticipated.
Bottom line: while
there were plenty of headlines driving it yesterday, the Market was the main
story.In my opinion, it could easily
remain that way until we know what the TLT, GLD and UUP markets have been
discounting (remember they started their tear long before we ever heard of the
coronavirus), whether they are correct and how that gets reflected in equity prices.
News on Stocks in Our Portfolios
Bank of Nova Scotia (NYSE:BNS): Q1 Non-GAAP EPS of
C$1.83 beats by C$0.08; GAAP EPS of C$1.84 misses
by C$0.08.
Revenue of C$8.14B (+7.1% Y/Y) beats by C$110M.
Bank of Nova Scotia (NYSE:BNS) declares CAD 0.90/share quarterly dividend, in line with
previous.
Home Depot (NYSE:HD): Q4 GAAP EPS of $2.28 beats by $0.17.
Revenue of $25.78B (-2.7% Y/Y) in-line.
Home Depot (NYSE:HD) declares$1.50/share
quarterly dividend, 10.3% increase from prior dividend of $1.36.
Economics
This Week’s Data
US
The February Dallas
manufacturing index came in at 1.2 versus expectations of 11.8.
Month to date
retail chain store sales declined at the same pace as in the prior week.
The December
Case Shiller home price index was unchanged..
International
Q4
Japanese leading economic indicators were reported at 91.6, in line.
Q4
German GDP growth came in at 0.0%, in line.
Other
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Intermediate
Term Uptrend 1368-3178Long Term Uptrend913-3191
2018
Year End Fair Value1700-1720
2019
Year End Fair Value1790-1810
Percentage Cash in Our
Portfolios
Dividend Growth
Portfolio56%
High
Yield Portfolio55%
Aggressive
Growth Portfolio56%
Economics/Politics
The Trump
economy is a neutral for equity valuations. The
data flow this week was negative: above
estimates: month to date retail chain store sales, May light vehicle sales, the
May ISM nonmanufacturing index; below estimates: weekly jobless claims, May
nonfarm payrolls, May ADP private payroll report, April construction spending,
the May ISM manufacturing and nonmanufacturingindices, April wholesale inventories/sales, the April trade deficit; in
line with estimates: weekly mortgage/purchase applications, the May composite and services PMI’s, March/April
factory orders, Q1 nonfarm productivity/unit labor costs.
As
were the primary indicators: April construction spending (-), May nonfarm
payrolls (-), March/April factory orders (0) and Q1 nonfarm productivity/unit
labor costs (0). I rate the week a negative.Score: in the last 191 weeks, sixty-three positive,
eighty-six negative and forty-two neutral.
Given the recent
string of disappointing data, it appears that the promising Q1 beginning of the
year has now fizzled to a halt---leaving my forecast intact.
The data from
overseas this week was a bit mixed though two global measures showed a slowing
of economic growth worldwide.So, a
neutral for our own economy.
[a] the May EU
manufacturing, services and composite PMI’s were above forecasts, unemployment
down ticked slightly while April retail sales were in line; the EU May CPI and
PPI were below consensus; Q1 EU employment and GDP growth were in line; the May
UK manufacturing PMI was well below estimates as was the May construction PMI; the
April German trade balance was less than anticipated while industrial production
was terrible; May German factory orders were stronger than forecast while the construction
PMI was disappointing,
[b] the May
Chinese Caixin manufacturing PMI was better than anticipated while the services
and composite PMI’s were less,
[c] April Japanese
household spending was less than anticipated while income was higher; the April
leading economic indicators were below estimates; the May manufacturing PMI was
better than expected but the services PMI was less,
[d] other global economic
indicators:
{i} ECB downgraded its
EU economic growth forecast,
{ii} JP Morgan’s
May global manufacturing PMI fell.
Developments
this week that impact the economy:
(1)trade: the main headline was Trump’s Mexican standoff.
[a] short
term, it worked as {overnight} Mexican officials agreed to increase efforts to
block migration to our southern border
{i} it
is the correct strategy to be fighting trade wars on multiple fronts. The Mexican victory aside, it almost certainly
will put business planning on hold,
{ii} using
trade weapons (tariffs) to address nontrade issues (immigration) isn’t a mistake
that will work against the US in future trade negotiations.I have already ranted over this several times
this week; so, I will end it there,
[c] all
that said, I continue to believe that the Donald’s objectives {controlling immigration;
resetting the post WWII trade/political regime} are worthy.It is some of his tactics that concern me.
Further, China continued
its stream of threats, fining Ford for antitrust violations, warning soybean
farmers that they be totally cut out of the Chinese market, threatening to
embargo rare earth shipments to the US and suggesting the depreciation of the yuan
was a possibility.
(2)the FTC and DOJ have started investigations of Alphabet,
Amazon, Facebook and Apple for potential antitrust actions.I have no idea of their guilt or innocence.But I do know that these companies are among US’s
crown jewels in the global technology race.A race which I remind you is one main reasons why the US is duking out
with China.I am mystified.
(3)the Fed: the highlight of the week was Powell basically
making a Draghi-esque statement, saying that the Fed would do whatever is
necessary to keep the economy [wink, wink, the Market] growing.He also suggested that the Fed continues to believe that
it can ever expand what it considers its ‘tool kit’ to exercise control over
the economy despite the fact that its old ‘tool kit’ [QE] produced only
marginal results.
But don’t forget,
two weeks ago, in the minutes from its latest FOMC , the Fed indicated that it believes that
inflation will move higher as a result of improving economic activity but that
it would likely take no policy actions for six to nine months even if inflation
were rising.It also said that at the
end of the six to ninemonth period, if
inflation hasn’t increased, it will consider cutting rates.
What could
account for another quick about face in policy?Drum roll, please---a decline in stock prices,
of course; which we know is the only thing that matters.In other words, anything that Powell/the Fed
says about policy reacting to economic conditions is meaningless drivel.
Bottom line:on a secular basis, the US economy is growing
at an historically below average rate.Although some recent policy changes are a plus for secular growth, they
are being offset by totally irresponsible fiscal (running monstrous deficits at
full employment adding to too much debt) and monetary (pushing liquidity into
the financial system that has done little to help the economy but has led to
the gross mispricing and misallocation of assets) policies.
Cyclically, the stronger
than expected Q1 GDP dataflow seems to have faded which is not surprising given
the lethargic global economy and the continuing threat of trade wars.So, I see no need to alter my forecast.
The Market-Disciplined
Investing
Technical
The Averages (25983, 2873) had yet another gangbusters’
day yet on an ever so slight increase in
volume.At least breadth improved,
finally.
The Dow ended above its 100 DMA for a second day (now
resistance; if remains there through the close Monday, it will revert to
support) and above its 200 DMA for a third day (now resistance); if it remains
there through the close next Monday, it will revert to support.The S&P closed above its 200 DMA (now
support) and above its 100 DMA for a third day, reverting to support.
So far, so good.The indices are pushing their way through testing multiple resistance
levels; and if Monday is an up day, all challenges will have been
successful.There remains only one minor
resistance level overhead; and if that falls, then it will be on to the all-time
highs---which if history is any guide, will become former all-time highs.
VIX was
actually up 2 ½ %---unusual on such a big up day in equity prices.That leaves it in a very short term uptrend and
above its 100 DMA (now support).Importantly, it challenged both of those levels intraday and then bounced.This pin action suggests way too much
complacency.It is still below its 200
DMA for a third day (now support; if it remains there through the close on
Monday, it will revert to resistance).
TLT was up 7/8% on big volume, finishing above both
MA’s (now support) and in a very short term uptrend.It is now 17 cents away from a twenty plus
year high.If it takes out that high,
the long term trend will reset to up.
The dollar declined another ½ %, but remained in a
short term uptrend and above both movingaverages (now support).Notably, it
filled the second lower gap up open intraday, eliminating the magnetic pull of
that gap.
GLD rose another ½ %, closing within a short term
uptrend, above both MA’s (now support) and is now nearing the upper boundary of
its intermediate term trading range.
Bottom line:the indices are almost through successfully challenging
the numerous resistance levels formed during the decline off the May double top.If Monday is an up day all challenges will be
complete; and only one minor resistance level will stand between them and their
all time highs.That is the good
news.The bad news is this has all been
done on very low volume, weak breadth, a VIX that is signalling extreme
complacency and bond, dollar and gold markets that are behaving like safety
trades.
The DJIA and the
S&P are well above ‘Fair Value’ (as calculated by our Valuation Model), the
improved regulatory environment and the potential pluses from trade notwithstanding.At the moment, the important factors bearing
on Fair Value (corporate profitability and the rate at which it is discounted)
are:
(1)the extent to which the economy is growing.The upbeat start to the year offered the
promise of some acceleration in sluggish US economic growth rate.Unfortunately, that promise is fading as the
world economy slows, trade wars threaten to make matters worse and the US
economy is burdened with the carrying costs of too large a deficit and national
debt.
My sluggish growth forecast is a slight plus but the odds of
an improvement have declined while those of even weaker growth increased.
(2)the success of current trade negotiations.If Trump can create a fairer political/trade
regime, it would almost surely be constructive for secular earnings growth.
However,
with the Market remaining at elevated levels, the Donald appears to be getting
more aggressive in pursuit of his stated goals---which to be sure are worthy
objectives.But in the case of China, I am
not yet convinced that he will go to the mat if stock prices are falling. I can’t
imagine the Chinese even considering making any compromise before the 2020
elections.If true, then Trump faces
more than a year of potential bad news on Chinese trade.So, the question remains will he fold if the
Market declines in a meaningful way?---which, of course, is a moot point right
now.
Further,
I don’t see anything of near term positive economic significance whatever the
outcome had been of Trump’s Mexican standoff.If tariffs had been imposed, how would that have been good?Slower growth?Increasing distrust of any trade agreement
made with Trump? Additional uncertainty in corporate suites about making
investment decisions?And where are the
pluses in victory?Trade levels, economic
and corporate profit growth will remain basically the same as before this dust
up.Sure, it is solves a long term problem
the results of which we may be able to measure positively sometime in the
future; but how does anyone quantify that impact today for Market valuation
purposes except to say that it is a psychological plus?
(3)the resumption of QE by the global central banks---which
soared into the spotlight this week with Powell’s Draghi-esque promise to take
whatever measures necessary to save the economy [the Markets]. The problem, of course, is that the Fed has
been, is and forever will be wrong on the economy; and it has proven that twice
in the last six months.
So, all
it has left is to react to the Markets.And if QEII, QEIII and Operation Twist are any guide, this should be a
plus for the equity prices.The question
here, is when will investors realize that a Fed run by academics with a flawed
model and an inflated view of their ability to control the economy has been a
disaster?I have no clue for the answer;
but until it occurs, the assumption has to be that the Market has limited
downside.That said, history says that
nothing goes on forever. (must read)
This is
a good historical review of Market performance following a first rate cut; however,
I would argue with the notion that the economy is in good shape.
(4)current valuations. I believe that Averages are grossly
overvalued [as determined by my Valuation Model].
What is so
mystifying to me right now is that [a] the US economic numbers are not that
great, the global stats are worse and, absent a US/China trade deal, are not apt
to get better---all of which augurs poorly for corporate profits, [b] long term
interest rates are plunging and the yield curve is flattening, both suggesting
that a weaker economy, and perhaps even recession, is in our future, [c] as I opined
above, the resolution to the Mexico immigration issue will do little to improve
the economy and yet [d] equity prices are rocketing toward their all-time highs.
This
makes no sense, except in the context that as long as the global central banks measure
their success by the performance of the stock Market and act accordingly---in
which case, fundamental economics and valuations will likely remain irrelevant.
As
prices continue to rise, I will be primarily focused on those stocks that trade
into their Sell Half Range and act accordingly. However, there are certain
segments of the economy/Market that have been punished severely (e.g. health
care) with the stocks of the companies serving those industries down 30-70%.I am compiling a list of potential Buy
candidates that can be bought on any correction in the Market; even a minor
one.
Bottom line: fiscal
policy is negatively impacting the E in P/E.On the other hand, a new regulatory environment is a plus.Any improvement in our trade regime with
China should have a positive impact on secular growth and, hence, equity
valuations---if it occurs.More important,
a global central bank ‘put’ has returned and, if history is any guide, will
almost assuredly be a plus for stock prices.
As
a reminder, my Portfolio’s cash position didn’t reach its current level as a
result of the Valuation Models estimate of Fair Value for the Averages.Rather I apply it to each stock in my
Portfolio and when a stock reaches its Sell Half Range (overvalued), I reduce
the size of that holding.That forces me
to recognize a portion of the profit of a successful investment and, just as important,
build a reserve to buy stocks cheaply when the inevitable decline occurs.
The
economy is a modest positive for Your Money. Another
slow week for data; though the good news is that it was weighted toward the
plus side: positives---January retail sales, weekly jobless claims, the NY Fed
manufacturing index, consumer sentiment and the January government budget
surplus; negatives---January industrial production and weekly mortgage and
purchase applications; neutral---weekly retail sales and December business
sales and inventories.
Though meager,
these stats nonetheless continue to support our forecast:
‘a below average secular rate of recovery
resulting from too much government spending, too much government debt to
service, too much government regulation, a financial system with an impaired
balance sheet.and a business
community unwilling to hire and invest because the aforementioned along with
the likelihood a rising and potentially corrosive rate of inflation due to
excessive money creation and the historic inability of the Fed to properly time
the reversal of that monetary policy.’
The pluses:
(1) our improving energy picture.The US is awash in cheap, clean burning natural gas....
In addition to making home heating more affordable, low cost, abundant energy
serves to draw those manufacturers back to the US who are facing rising foreign
labor costs and relying on energy resources that carry negative political
risks.
(1) a
vulnerable global banking system.JP
Morgan just can’t stay out of the news.This week witnessed another report on their trading operations in which
the measure that traders used to control risk in their portfolios substantially
understated that risk due to a programming error; in other words, JPM
has been carrying more risk in its trading operations than it thought.This simply illustrates [one more time] [a] the
potential risk that exists on any one bank’s balance sheet and [b] because of the
counterparty risk via derivatives becomes a potential risk on all banks’
balance sheets.
‘My concern here is that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and
well managed as we have been led to believe and, hence, are highly vulnerable
to future shocks, particularly a collapse of the EU financial system.’
(2) the ‘debt ceiling/sequestration/continuing resolution cliff’. In the ongoing sequestration debate, this week
Obama, in His SOTU, again refused to take tax increases off the table and
doubled down by offering a full menu of new programs that He wants to initiate.He claimed that they won’t cost a dime,
though the universe knows that is simply more of His bulls**t.
On the other
hand, the GOP is hanging tough on allowing the sequester to go through.As you know, I am all for that occurring,
absent a compromise that would include an equal but more targeted spending
reduction.
However as I
have pointed out, it would not immediately solve our debt and deficit problems---although
it would be the first sign in over a decade that someone in Washington is
actually prepared to take a fiscally responsible action.
Nor would it,
in the near term, improve the economic outlook:
“according to the Rogoff and Reinhart
study, countries whose national debt is more than 90% of GDP grow at below average rates as a result
of being encumbered by policies that are required in order to service that
debt.Today that debt to GDP ratio in the US is 105%.So while the sequester may be a first step
in the long term journey toward fiscal responsibility, the policy of reduce
spending must be sustained long enough to drive that debt to GDP ratio back to the point where the
economy is free to grow at its historic secular rate.Hence, in the short term, the sequester and
any other subsequent spending cuts will not have an immediate impact of
economic/profit growth’
Of course, the
sequester hasn’t occurred yet; and Obama is not going to let this happen
unchallenged.With only two weeks to go,
He will undoubtedly turn up the heat; and given His acumen as a politician,
gosh only knows what He will pull out of His bag of tricks.
So while I am root, root,
rooting for the home team [sequester advocates], until I see it happen, I will
remain a nonbeliever. In addition, ‘I maintain
my thesis that this is ‘a line in the sand’ moment---the ruling class either
puts government finances on a fiscally responsible course or we will be firmly
on a course to a European nanny state [many of whom are rapidly approaching
bankruptcy].’
A problem related to the ‘fiscal cliff’ is the
potential rise in interest rates and its impact on the fiscal budget.As I have noted previously, the US government’s debt has grown to such a size
that its interest cost is now a major budget line item---and that is with rates
at/near historic lows.Moreover, government
debt continues to increase and the lion’s share of this new debt is being
bought by the Fed.
So the risk here is two fold: [a] to the
Fed---its balance sheet is levered to the point that Lehman Bros. looks like it
was an AAA credit.So if interest rates
go up {and prices go down}, the very thin equity piece of the balance sheet
would disappear.The Fed would then be
technically bankrupt. and [b] to the Treasury---it must pay the interest
charges. Hence, if rates go up, the
interest costs to the government go up; and if they go up a lot, then this
budget line item will explode and make all the more difficult any vow to reduce
government spending as a percent of GDP and/or
manage the fiscal cliff.
[a] the potential negative impact of central bank money printing.My initial concern with rampant money
printing [aside from deforestation] was either recession or price
inflation.To date neither has
happened.But the longer the expansion
of bank reserves goes on and the larger they become, the more difficult it will
be to return to normal without either pushing the economy into recession [if
the tightening is too big too fast] or creating inflation [if too slow].
Since the Fed
has never gotten this exit correct, more often erring on the side of too little
too late, my primary worry is inflation.Here are the problems:
First--[a] Bernanke has already said {too many times to count} that when it comes to balancing the twin
mandates of inflation versus employment, he would err on the side of
unemployment {that is, he won’t stop pumping until he is sure unemployment is
headed down}.That can only mean that
the fires of inflation will already be well stoked before the Fed starts tightening
and [b] history clearly shows that the Fed has proven inept at slowing money
growth to dampen inflationary impulses---on every occasion that it tried.
‘Second, the bond market may not even give the Fed the luxury of
deciding when it wants to start tightening.If bond investors get spooked enough and start imposing some serious
whackage on bond prices, the Fed will be faced with a Hobson’s choice---hold on
to the bonds, suffer the accompanying price depreciation and print more money
to counter the loss on its balance sheet or sell the bonds faster than it planned,
in effect tightening money policy faster than it would like and raising the
risk of creating a recession.
‘Third, an overly easy monetary policy
generally results in the depreciation of the currency of that bank’s country which
in turn improves that country’s trade balance and strengthens its economy.That is great unless its trading partners get
pissed and commence their own ‘easy money/currency depreciation’ effort. At that point, you got yourself a currency
war; and that seems to be the direction that the major economic powers are
headed in.’
This week, the
G20 chose to completely ignore the recent moves by the Japanese to depreciate
the yen just like they have largely closed their eyes to US
money printing.So far, it has been easy
enough to ignore our Fed’s easy money policy because it has not shown up in the
dollar exchange rates to date. On the
other hand, the yen has already depreciated 20%---a little tougher to
overlook.The potential problem arises
if at some point, the Japanese yengets
cheap enough and/or investors quit giving the Fed a free ride and everyone else
in the world starts retaliating---at that point, we have a very serious problem.
[b] a blow up in the Middle East.It was mostly quiet on this front this
week.However, it would likely be a
mistake to assume that all is well.My
concern is that one or more of the current hot spots [Syria,
Egypt, Algeria,
Mali, Iran,
Israel] will escalate
in violence which in turn leads to a disruption in either the production or
transportation of Middle East oil, pushing energy prices
higher.
(4)finally, the sovereign and bank debt crisis in Europe
remains a major risk to our forecast.This week, the EU economic stats showed the
continent in recession [which won’t help sovereign and bank balance sheets],
the elections in Italy
got iffier by the day [with an anti-austerity Berlusconi gaining in the polls] and
the G20 in a state of denial regarding the impact of a weakening yen on EU
production and trade.
Nevertheless,
investors are back doing what they do best which is giving the eurocrats a free
pass on any hair brained, destructive scheme they come up with---despite the
fact that they have done nothing to either correct their countries’
sovereign/bank debt problems or to lessen the banking community’s exposure to
the derivative markets.
Bottom line: amazingly enough, the US
economy continues to grow in spite of dysfunctional monetary and fiscal
policies.While not the ideal scenario,
it does, of course,fit our 12-18 month forecast.Whether or not this remains our long term
outlook depends on our ruling class changing their irresponsible ways.
On fiscal
policy, I have said repeatedly that I considered the sequestration debate a
line in the sand. If it happens, then the economy has a chance of righting
itself---assuming the fiscally responsible crowd can continue to hold the line
until the debt to GDP and government
spending to GDP return to historically
normal levels.However, even if they
succeed, growth won’t return to its higher secular rate over night and hence
will have no immediate impact on our Economic Model.
If it doesn’t
happen, then I believe that the US
will be locked into the European economic model---slow growth, intrusive taxes,
profligate spending.
On monetary
policy, I can’t see how the US
escapes the consequences of the current Fed policy of infinite money
creation.For the moment, investors
apparently are enjoying the liquidity buzz enough that tomorrow doesn’t
matter.Someday, it will; and when that
occurs, our Economic Model will most probably change---and not for the better.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies.The likelihood of those happening has
probably increased as the EU economy slips further into recession, political
stability is again being challenged [Italy, Spain, Greece] and the eurocrats
adopt the ostrich strategy in dealing with the ‘all in’ currency deprecation
policy of the Japanese.That said, nothing
will happen as long as investors maintain their current optimism.Regrettably, this calm could have been used
by the political class to actually do something constructive to solve the
sovereign/bank balance sheet problems; but thus far, they have done
nothing.Which begs the question of whence
judgment day?
This week’s
data:
(1)housing: weekly mortgage and purchase applications were
down big,
(2)consumer: weekly retail sales were mixed while January
retail sales rose in line with forecasts; weekly jobless claims fell much more than
expected; the University of Michigan’s
final February index of consumer sentiment came in above estimates,
(3)industry: December
business inventories and sales were up less than anticipated; January
industrial product was down versus forecasts of an increase; the New York Fed
February manufacturing index was a blow out,
(4)macroeconomic: the budget was in surplus in January.
The Market-Disciplined Investing
Technical
The indices
(DJIA 13981, S&P 1519) finished within both their short term uptrends
(13400-14048, 1458-1527) and intermediate term uptrends (13357-18357, 1413-2008).
They
both continue to hug the upper boundary of their short term uptrends and certainly
act like getting to 14140/1576 will not be a problem.
Volume on Friday
was up while breadth was mixed---though the on balance volume indicator
continues to not confirm the recent move up.The VIX was off but still closed within its intermediate term
downtrend---a positive for stocks.
GLD was off,
remaining in its short term downtrend.As you know, this week itbroke
to the downside out of the developing pennant formation and then fell below a
secondary support level.Technically,
this is not a plus for GLD.
(1)the Averages are trading within their short term
uptrends [13400-14048, 1458-1527] as well as their intermediate term uptrends
[13357-18357, 1413-2008].
(2) long term, the Averages are in a very long term [78 years] up trend
defined by the 4546-15148, 651-2007 and a shorter but still long term [13
years] trading range defined by 7148-14198, 766-1575.
The DJIA (13981)
finished this week about 23.2% above Fair Value (11350) while the S&P (1519)
closed 8.0% overvalued (1406). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed compromise on the
fiscal (debt ceiling/sequestration/continuing resolution) cliff, continued
money printing, a historically low long term secular growth rate of the economy
and a ‘muddle through’ scenario in Europe.
The economy is
tracking with our forecast; so as I noted above, no alterations are needed to
our Economic Model. Neither is it
necessary to change the assumptions in our Valuation Model.However, the outcome of the sequestration
battle could impact both, but on a very long time horizon, i.e. if the spending
cuts envision in the legislation are implemented, that could mark a turn toward
fiscal responsibility.But before
getting too jiggy about the whole thing, there are a number of big ‘ifs’ that
must be dealt with.
First and
foremost is whether or not we even get the sequester.Sure the GOP is hanging tough for now.But Obama has yet to put on the inevitable
full court press.If republicans fold,
nothing changes now or in the future.
Second, if
sequestration takes place, it should not be looked as anything more than a
symbolic first step.As Rick Santelli
noted, the total sequestration amount is 1/3 of 1% of the budget---hardly a
reason to start popping champagne corks over some newfound austerity.Further, it is not even a cut in spending, it
is a cut in the rate of growth of spending.The point being that (1) unless this action is followed by more such
actions, sequestration will mean nothing and (2) it takes time before any
cumulative reductions in spending impacts our Economic Model.
On the other
hand, if progress is made, then valuations will likely begin rising before any
noticeable impacts on economic growth are visible.So there is the possibility under the best
case scenario of more optimistic assumptions in our Valuation Model even before
those in our Economic Model.
As far as
monetary policy goes, our Models assume a rising inflation rate resulting from
the Fed’s current aggressive money printing.I see almost no way of improving those assumptions.Sooner or later, we will be faced with either
a recession (if the Fed gets too tight too fast) or inflation (if the Fed does
its usual slow on the draw shtick)---which as you know is my scenario of choice.In the former case, our Models would probably
change; in the later, not so much.
Meanwhile,
Euroland continues to slide toward recession and instability.If there were ever a perfect example of the
old saw of Nero fiddling while Rome
burned, the eurocrats fit it to a tee.They did nothing in the recent period of relative economic and Market
calm to address the sovereign/bank solvency problem.So I can only assume that when, as and if the
world awakes from its euphoric slumber and takes Europe to task, the tail risks
of EU sovereign/bank insolvencies potentially threatening the global financial
system have not lessened.
My investment conclusion: nothing has happened that would warrant a
change in the assumptions in our Valuation Model.Hence, stocks remain overvalued.There is the chance that somewhere out there
in the future if sequestration occurs and if it is a precursor to further moves
to fiscal responsibility that our growth rate assumptions in the Economic Model
and our discount assumptions in the Valuation Model could improve.But it is far, far too soon to make that bet.
The thing that could impact our Models
near term is a crisis in Europe.Economic and social conditions are
deteriorating, raising the odds that our ‘muddle through’ scenario will prove
inaccurate.My problem, as I have
frequently noted, is quantifying the downside of not ‘muddling through’.
The ‘tail risks’ of spiking
interest rates and inflation in the US and a financial crisis in Europe keep
our Portfolios over weighted in cash
Finally, GLD has me completely baffled.It has broken down technically in a big
way.While I believe our Portfolios will
need the inflation protection offered by gold at some time in the future,
clearly the Market doesn’t think that time is now.As you know, I am not inclined to risk
principle to prove a point, so our Portfolios have Sold out of their GLD, at
least temporarily.
This week, our Portfolios also
continued to lighten up on either fundamentally or technically overextended
stocks.
The latest from Charles Biderman (4 minute video):
(2)we continue to include gold and foreign ETF’s in our
asset mix because we continue to believe that inflation is a major long term
risk [which is now under review].An
investment in gold is an inflation hedge and holdings in other countries
provide exposure to better growth opportunities.
(3)defense is still important.
DJIAS&P
Current 2013 Year End Fair Value*116001440
Fair Value as of 2/28/13113501406
Close this week139811519
Over Valuation vs. 2/28 Close
5% overvalued119171476
10%
overvalued124851546
15%
overvalued130521616
20%
overvalued136201687
25%
overvalued141871757
Under Valuation vs.2/28 Close
5%
undervalued107821335
10%undervalued10215126515%undervalued96471195
* 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 termcyclical
influences.The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years with
somewhat higher inflation.
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 40 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.
