The Closing Bell
12/5/15
Statistical
Summary
Current Economic Forecast
2014
Real
Growth in Gross Domestic Product +2.6
Inflation
(revised) +0.1%
Corporate
Profits +3.7%
2015
estimates
Real
Growth in Gross Domestic Product (revised)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 16919-18148
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5471-19343
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2016-2104
Intermediate
Term Uptrend 1975-2768
Long Term Uptrend 800-2161
2014 Year End Fair Value
1470-1490
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 mixed to slightly upbeat: above estimates: the November Dallas
Fed manufacturing index, month to date retail chain store sales, the November
Markit manufacturing PMI, October construction spending, October factory
orders, November light vehicle sales, weekly purchase applications, the November
ADP private payroll report and November nonfarm payrolls; below estimates: the November
Chicago PMI, October pending home sales, November ISM manufacturing and
nonmanufacturing indices, weekly mortgage applications, third quarter unit
labor costs and the November trade deficit; in line with estimates: third
quarter nonfarm productivity and weekly jobless claims.
The primary
indicators were also mixed to positive: construction spending [+], factory
orders [+], nonfarm payrolls [+] November ISM manufacturing and
nonmanufacturing indices [- -]. Finally,
the anecdotal evidence was negative: Black Friday sales [-], Cyber Monday sales
[+], truck loadings [-], the latest Atlanta Fed fourth quarter GDP growth
estimate [-] and Citi sees the odds of a recession at 65% [-].
In addition, the
attacks in California raise the prospect that the war on terror may have
reached our shores with same ramifications as the attacks in Paris---less
travel, less entertainment outside the home, added costs of stepped up
security. Of course, we won’t know this
for a while.
In sum, the data
this week was again mixed (now one upbeat week, two mixed weeks and eleven
negative weeks in the last fourteen), providing some limited evidence that the
economy is not losing strength but can in no way be interpreted as ‘improving’
(sorry, Janet).
Still, we can’t
ignore those three weeks of mixed to better numbers; that keeps me hopeful the
slide in economic activity has stabilized and the threat of recession lessened.
However, three nonnegative weeks out of fourteen is a pretty thin reed on which
to hang those hopes. For the moment, I
am sticking with our current forecast; but the risk of recession remains above
average.
Helping out the
prospects of economic stabilization were the improved overseas data. This is the first week in a long time that
the numbers were actually upbeat. That
said, one week does not a trend make.
The Fed remained
center stage this week with two speeches from Yellen and the release of the
latest Fed Beige Book. Both supported the
latest Fed narrative that a December rate hike is in the cards. Aside from reiterating the questionable
storyline that economy was progressing, Yellen made the ridiculous statement
that the Fed needed to raise rates soon because the economy was improving so
fast that to delay the rate hike would be to risk being too late. News flash Janet, you are already too late
by eighteen months.
In summary, the US
economic stats took another pause in their downward trajectory. That is the third in the last seven weeks, so
it may be that the numbers are stabilizing.
Meanwhile, the international data remains sub-par---this week’s stats
notwithstanding. In the meantime, the
Fed is praying the Market holds in the face of a more likely December rate hike
so it can make at least a token move toward monetary normalization.
Our forecast:
a much below average secular rate of
recovery, exacerbated by a declining cyclical pattern of growth with an
increasing chance of a recession resulting from 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.
Update on big
four economic indicators (medium):
The
negatives:
(1)
a vulnerable global banking system. This week, the news was actually good: the Fed adopted measures to curb its emergency
lending power, including the ability to offer below Market rates. This is yet another step to avoid the bail
out another ‘too big to fail’ bank and will hopefully further improve the
public’s confidence that [a] the US financial system is increasingly sound and [b]
the game isn’t rigged for the big boys.
I have spent volumes of ink in these pages criticizing the
criminal behavior of the banksters and complicity of the regulatory authorities. But credit where credit is due---both the EU
and US banking powers have been enforcing measures to address the capital inadequacies
of the big banks and speculative behavior of their proprietary trading desks. As a result, US and UK banks have been
passing increasingly stringent ‘stress tests’.
Unfortunately, S&P views this as a negative. This week it downgraded the credit rating of
eight large US banks because the odds of them getting bailed out has risen.
Of course, we are not going to know just how effective
these steps will be until the next crisis.
However, they clearly will have some impact and, hence, whatever
problems may arise, they are certain to be less than they would have been if
nothing were done. The biggest question in
my mind is how much risk is embedded in the derivative portfolios currently on
bank balance sheets. Unfortunately, I don’t
think anyone will know the answer to that until after the fact.
Here is an attempt to answer that question. It is a bit long and a bit in the weeds, but
a must read:
Bottom line, while I still consider this a risk, as the
result of recent rules and regulations imposed by the regulators, it is likely
that the risks are not as big as they were in the prior crisis.
‘My concern here.....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 in the international financial
system.’
(2) fiscal/regulatory
policy. This week, senate and house
conferees reached an agreement on a $305 billion highway bill which they say
will require no debt financing. The good
news is that this measure not only addresses the deteriorating US
infrastructure but also creates jobs both directly and indirectly. The bad news was that it would be financed
with smoke and mirrors which means our ruling class still can’t manage an
honest budget even when it tries to do the right thing.
(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.
As I noted
above, Yellen reiterated that a December rate hike was likely to occur. She made it more emphatic by saying that if
the Fed didn’t raise rates now, it risked being too late---a statement that I believe
that she will come to regret. In my
opinion, the preponderance of evidence is that the Fed is already too late and
that the economy is weakening from an already below average historical rate of
recovery.
Making matters
worse is that the rest of the world’s central banks recognize that economic
conditions are frail and are planning new QE measures. That became a point of confusion this week as
Draghi/ECB made hawkish sounds on Thursday.
When the Market reacted violently to those comments, they were quickly
walked them back on Friday. The point here
being that a huge divergence in central bank monetary policy is upon us and
there is uncertainty as to the economic/Market consequences.
‘To be clear, I am not concerned about the
economic effect of a 25 basis point rise in the US Fed Funds rate. That won’t likely make a difference one way
or the other. What I am worried about is
investors’ concluding that (1) not one of the globe’s central bankers have a
f**king clue what they are doing, i.e. the Fed is pretending to be tightening because
economic condition in the US are just swell when in fact they are not yet the
ECB, the Bank of Japan and the Bank of China are cranking up QE because their
economic growth rates are just as feeble as our own and (2) decide that
valuations don’t properly reflect reality.
Think about the perverse logic here and tell me all is well.’
You know my
bottom line: sooner or later, the price will be paid for asset mispricing and
misallocation. The longer it takes and
the greater the magnitude of QE, the more the pain.
(4) geopolitical
risks: after the Paris tragedy, the question was, is the war now expanding
geographically? I am not sure if the
California shootings are the answer. But
if it is yes, there will likely be more such incidents in the near future. Of course, the real problem is that no one
has the foggiest notion how to solve the Middle East/Islamic radicalism quagmire,
all that neocon bulls**t notwithstanding.
How many times do we have to kill young Americans only to make the
Middle East turmoil all the greater? This
country needs a radical change in direction in its Middle East policy; and I
fear that only a second 9/11 type tragedy will cause that to happen.
This is a great
analysis of the problem but offers no solution, making it useless (medium):
(5) economic
difficulties in Europe and around the globe. This week’s overseas economic stats improved [mixed]
for the first time in months: November
Chinese manufacturing PMI was at a three year low while the services PMI was up
slightly; November Japanese and EU Markit manufacturing PMI’s were up; EU
November services and composite PMI’s came in below expectations while the
Chinese November composite PMI was above; EU jobless rate was down; November EU
inflation was lower than anticipated.
The bad news is
that the emerging markets still have mega-problems (medium):
More on that subject
(short):
And even more (medium and a
must read):
As I am
fond of saying, one week of good news does not mean a change in trend and the
trend in the rest of the world’s economic has been nothing to be enthusiastic
about. As a result, the yellow flashing
on our global ‘muddling through’ assumption continues to flash; and a flashing
red light is not that far away.
Bottom line: the US data continues to reflect very sluggish
growth in the economy, though its rate of slowing may have stabilized. However, global economic trends are still
deteriorating; and the Fed, paralyzed by fear of the consequences of prior
policy mistakes, has potentially put itself in an untenable position.
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: October pending home sales were down much more
than anticipated; weekly mortgage applications were down but purchase applications
were up,
(2)
consumer: month to date retail chain store sales were strong
versus the prior week; November light vehicle sales were slightly over consensus;
the November ADP private payroll report was stronger than expected; weekly
jobless claims were in line; and November nonfarm payrolls were better than projections,
(3)
industry: the November Chicago PMI was very
disappointing; the November Market manufacturing PMI was slightly above
estimates; both the November ISM manufacturing and nonmanufacturing indices
were well below forecast; October factory orders were slightly above consensus;
October constructions pending was better than anticipated; the November Dallas
Fed manufacturing index was down but not as much as expected,
(4)
macroeconomic: third quarter nonfarm productivity rose
in line while unit labor costs were twice what was estimated; the November US
trade deficit was larger than forecast.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17847, S&P 2091) had a roller coaster week, though little changed
technically speaking. The Dow ended [a]
above its 100 moving average, which represents support, [b] above its 200 day
moving average, now support having negated Thursday’s challenge, [c] within a
short term trading range {16919-18148}, [c] in an intermediate term trading
range {15842-18295}, [d] in a long term uptrend {5471-19343}, [e] and still
within a series of lower highs.
The S&P
finished [a] above its 100 moving average, which represents support, [b] above
its 200 day moving average, now support, having negated Thursday’s challenge
[c] in a short term trading range {2016-2104}, [d] in an intermediate term
uptrend {1975-2768}, [e] a long term uptrend {800-2161} and [f] still within a
series of lower highs.
Volume rose;
breadth improved. The VIX (14.8) was down
19%, ending [a] below its 100 day moving average, now resistance, [b] in a
short term downtrend, having negated Thursday’s challenge and [c] in
intermediate term and long term trading ranges.
Insider
selling near highs. Tell me that is a
good thing (short):
The long
Treasury was strong on Friday after Thursday’s shellacking, remaining below its
100 day moving average, now resistance and within very short term, short term
and intermediate term trading ranges.
GLD smoked on
Friday but still ended [a] below its 100 day moving average, now resistance and
[b] within short, intermediate and long term downtrends. The rally may have been the result of Draghi
walking back his hawkish tone (easy money/low rates are good for gold).
Bottom line: despite
the intraweek volatility, the Averages ended fractionally off their close last
week. So their technical position didn’t
really change, including the fact that they remain in a series of lower
highs---that is the bad news.
The good news is
that we are in a period of historically strong seasonal upward bias---which is
demonstrable given that economic data reflects stagnation at best, the Fed is hell
bent on raising rates whatever the numbers even as the rest of the world’s central
banks are easing and the recent spread of the war against radical islam outside
the Middle East. I can only assume that
this positive bias will be with us through the New Year, which cranks up the
odds in the interim of challenges to the indices all-time highs and upper boundaries
of their long term uptrends. But as you
know, I don’t believe that those challenges will be successful.
Technical damage
control (short):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17847)
finished this week about 45.1% above Fair Value (12300) while the S&P (2091)
closed 37.1% overvalued (1525). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe, Japan and China.
The recent trend
towards more stable economic numbers got another boost this week. So I am not giving up on the notion just yet
that conditions could be leveling out; but three mixed to upbeat weeks in the
last fourteen is not a lot to hang that hope on. Further poor aggregate data will continue to push
the risk of recession higher, especially if the anecdotal evidence keeps
deteriorating.
In addition, the
global economy remains a mess, this week’s better economic data
notwithstanding. Finally, the heightened
risk of more terrorists attacks and the potential economic fallout if those
attacks prove not to be one off events, will make it all the more difficult for
the US to continue to grow.
In sum, the US economic picture is a bit murky at the
moment; although, not so much so that we can’t conclude that it is weaker than
it was three months ago. In the
meantime, the global economy is lousy and the recent terror attacks could
likely spawn additional weakness. The risk here is that many Street forecasts
are too optimistic; and if they are revised down, it will likely be accompanied
by lower Valuation estimates.
This week, Yellen
reaffirmed that a December rate hike was highly likely. As you know, I believe that a return to
normalized monetary policy will be bad for stocks; and it could be made all the
worse if the rest of the world’s central banks are easing---which it seems
apparent that they are going to do. The
ECB has already loosen monetary policy; and though the initial Market reception
to a less aggressive easing was quite negative, Draghi quickly crawfished back
to his ‘whatever is necessary’ narrative.
The one caveat is that I am not sure just how fast Markets will react to
the divergence of central bank monetary policy.
However, whenever and whatever happens, I believe that the cash
generated by following our Price Discipline will be welcome when investors wake
up to the Fed’s malfeasance because I suspect the results will not be pretty.
Net, net, my two
biggest concerns for the Markets are (1) declining profit and valuation
estimates resulting from the economic effects of a slowing global economy and
(2) the unwinding of the gross mispricing and misallocation of assets following
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. Unfortunately,
our own assumptions may be too optimistic, making matters worse.
The assumptions
in our Valuation Model have not changed either; though at this moment, there
appears to be more events (greater than expected decline in Chinese economic
activity; turmoil in the emerging markets and commodities; miscalculations by
one or more central banks that would upset markets; a potential escalation of
violence in the Middle East and around the world) that could lower those
assumptions than raise them. That said, our
Model’s current calculated Fair Values under the best assumptions are so far
below current valuations that a simple process of mean reversion is all that is
necessary to bring Market prices down significantly.
I
can’t emphasize strongly enough that I believe that the key investment strategy
today is to take advantage of any further bounce in stock prices to sell any
stock that has been a disappointment or no longer fits your investment criteria
and to trim the holding of any stock that has doubled or more in price.
Bear
in mind, this is not a recommendation to run for the hills. Our Portfolios are still 55-60% invested; but
their cash position is a function of individual stocks either hitting their
Sell Half Prices or their underlying company failing to meet the requisite
minimum financial criteria needed for inclusion in our Universe.
More
on valuation (must read):
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 12/31/15 12300
1525
Close this week 17847
2091
Over Valuation vs. 12/31 Close
5% overvalued 12915 1601
10%
overvalued 13530 1677
15%
overvalued 14145 1753
20%
overvalued 14796 1830
25%
overvalued 15375 1906
30%
overvalued 15990 1982
35%
overvalued 16605 2043
40%
overvalued 17220 2135
45%
overvalued 17835 2211
50%
overvalued 18450 2287
Under Valuation vs. 12/31 Close
5%
undervalued 11685
1448
10%undervalued 11070 1372
15%undervalued 10455 1296
* 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.
