4/2/16
Statistical
Summary
Current Economic Forecast
2015
estimates
Real
Growth in Gross Domestic Product (revised)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 15431-17758
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5471-19343
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 1867-2081
Intermediate
Trading Range 1867-2134
Long Term Uptrend 800-2161
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 maybe providing a temporary upward bias to equity valuations. The
stats this week were mixed to slightly positive: above estimates: month to date retail chain
store sales, February personal income, March consumer confidence and sentiment,
February pending home sales, weekly purchase applications, March Chicago PMI
and the March ISM manufacturing index; below estimates: weekly mortgage
applications, the March ADP private payroll report, weekly jobless claims, March
light vehicle sales, the March Markit manufacturing PMI, February construction
spending and the January trade deficit; in line with estimates: the Case
Shiller home price index, February personal spending, the February PCE deflator,
the March Dallas Fed manufacturing index, March nonfarm payrolls/unemployment.
Likewise the
primary indicators were mixed to positive: February personal income (+), the
March ISM manufacturing index (+), February personal spending (0), March
nonfarm payrolls (0) and February construction spending (-). I am counting this as a plus week, so for
those keeping a running score, in the last 30 weeks, seven have been positive
to upbeat, twenty two negative and one neutral.
However,
weighing on the negative side, the Atlanta Fed revised its first quarter GDP
estimate down to 0.6%. This is the third
downgrade in as many weeks.
One thing that
stands out, I mentioned on Thursday; and that is that the stats out of the
manufacturing sector have improved markedly over the last two weeks (the
regional Fed banks’ manufacturing indices along with the March Chicago PMI and
the ISM manufacturing index). This
sector of the economy has been the weakest of late; so any improvement is
clearly welcome.
A couple of
points: (1) two weeks in not enough data to warrant a change in outlook, (2)
remember the government revised its seasonal adjustment factors for the first
quarter---which could, at least partially, explain the improvement, (3) the
international economic numbers have been and remain terrible; if US industry manages
to overcome this enormous headwind, then it will be impressive, indeed. I am just not sure how probable that is, and
(4) nonetheless, I am impressed with these results and have turned on the
flashing yellow light to indicate that I may have jumped the gun on my
recession call.
The other big
story of the week was Yellen’s trashing of the Fed hawks. That keeps investors tip toeing through the
tulips but (1) continuing this back and forth, on again, off again rate hike
dialectic is likely to destroy what little credibility the Fed still has left
and (2) her concern about the global economy confirms that it is in worse shape
than anyone is willing to admit.
Adding insult to
injury, the international economic numbers were abysmal. Hence, there is
nothing here to qualify as a positive for our economy.
In summary, the US
economic stats were slightly to the upside this week while the international data
remains depressing. Meanwhile, the Fed
is doing its utmost to confuse and confound.
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 economy at
stall speed (medium):
Do
we now have to start worrying about stagflation? (medium):
The
negatives:
(1)
a vulnerable global banking system. This week, there were a couple of articles on
the exposure of regional banks to energy loans.
They were not doomsday forecast but they did point out potential
problems. E.g.
(2) fiscal/regulatory
policy. With the election season now in
full swing, we are likely to get no new developments by way of fiscal/regulatory
policy [except for more empty promises] until at least early 2017.
The
administrative state (short):
(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 have
conveyed in our Morning Calls, Yellen reversed all of last week’s hawkish
statements from regional Fed chiefs. I
said in last week’s Closing Bell: ‘I have
railed against this ‘on the one hand, on the other hand’ crap that we have been
fed for far too long. In my opinion,
this is another perfect example that the Fed has painted itself into a box, it
knows it and is trying to buy time by blowing smoke our skirts in the hopes
that some miracle will bail them.’
One of the
central points in Yellen’s speech was the concern about the global economy,
pointing to China as the major worry. I
think that this confirms John Mauldin’s thesis that China told the G20 to lay
off the competitive devaluation or else.
Yellen’s statement as well as the actions of the other major central
banks certainly confirm it. The
important point here is not that China muscled the world’s central bankers but
why it was done, i.e. the Chinese economy is in much worse shape than anyone is
willing to admit, which confirms my concern about a weakening global economy.
You know my
bottom line: QE and negative interest rates have done nothing to improve any
economy, anywhere, anytime. Sooner or
later, the price will be paid for the resulting asset mispricing and
misallocation. The longer it takes and
the greater the magnitude of QE, the more the pain.
(4) geopolitical
risks: the terrorists’ bombings just keep on coming with huge casualties in
Pakistan at an Easter celebration. Europe is in turmoil over immigration and
assimilation policies. Russia appears to
be increasing its forces in Syria instead of withdrawing them. And Iran has thrown the nuclear agreement
with the US in the trash can with little response to date.
There is a
decent chance of an explosive event stemming from one or more of the
aforementioned, though I have no idea just how big it could be or which one is
more likely to occur.
Meanwhile in
Europe (medium):
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week were quite negative, though several Chinese ‘official’ datapoints were
positive: China reported an increase in
industrial profits in February and manufacturing and services PMI’s in March;
but remember they lie a lot. Indicative
of that [a] the New York based China Beige Book reported data not consistent at
all with these numbers---capex at its lowest level in the history of the survey
[five years] and employment at a four year low, [b] the Asian Development Bank
lowered its forecast for Chinese GDP growth in 2016 and 2017, and [c] S&P
lowered China’s credit rating.
Japan recorded February retail sales down 2.3% and
industrial output down 6.2%, lower March business sentiment and a decline in the
manufacturing PMI [how is that QE and NIRP working for you, Mr. Abe?]
South Korean
trade data stunk, March EU inflation declined, March EU consumer prices dropped,
the March EU flash manufacturing PMI rose slightly while the UK PMI declined and
Italian unemployment rose while German unemployment was unchanged.
In other news, Libya, Iraq and Iran have indicated
that they won’t attend the April OPEC meeting; and, of course, the US won’t be
there. And adding to this charade, Saudi
Arabia said that it will only freeze oil production if Iran joins the
effort. What freeze?
The bottom line: the data we got
was not encouraging. And Ms. Yellen
seems to agree that the global economy remains a major headwind.
Bottom line: the US data in aggregate continues to point
toward a recession, though my anxiety has increased that I acted too quickly in
making that call. The global economy did
nothing to brighten the outlook. Oil may be about to roll over again. And the global central banks are doing everything
possible to confuse and confound the Markets in hopes that a miracle will allow
them to exit QE without much damage.
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: February pending home sales were double
estimates; the January Case Shiller home price index rose more than
anticipated; weekly mortgage applications declined but purchase application
were up,
(2)
consumer: February personal income was ahead of
consensus while spending and the PCE deflator were in line; both March consumer confidence and sentiment
were higher than projected; month to date retail chain store sales were
stronger than the prior week; the March ADP private payroll report came in
below expectations as did weekly jobless claims; March nonfarm payrolls were
down but slightly better than estimates; unemployment rose; March light vehicle
sales came in below projections,
(3)
industry: the Dallas Fed March manufacturing index was
negative but better than forecast; the March Chicago PMI was much better than
anticipated, the March Markit PMI was slightly worse than consensus while the
March ISM manufacturing index was better; February construction spending was
awful,
(4)
macroeconomic: the January US trade deficit was lower
than expected; however, both imports and exports declined.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17792, S&P 2072) had a great week, helped along by the Yellen dovish,
creampuff speech and end of the quarter window dressing. On Friday, volume rose though it remains at
low levels; breadth improved though it remains mixed overall. The VIX was banged all week, keeping it in a
very short term downtrend and below its 100 day moving average. However, it is now within striking distance
of the 10-12 price level which offers good value as portfolio insurance.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] above the upper boundary of its short term trading
range {15431-17758}; if it remains there through the close on Tuesday, it will
reset to an uptrend, [c] in an intermediate term trading range {15842-18295}
and [d] in a long term uptrend {5471-19343}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term trading range {1867-2081},
[d] in an intermediate term trading range {1867-2134} and [e] in a long term
uptrend {800-2161}.
The long
Treasury stabilized this week. After voiding
a very short term downtrend last week, it is developing a very short term
uptrend. It finished well above its 100
day moving average and above a Fibonacci support level. Hopefully, this may be a sign that the recent
decline is over.
GLD continues to
digest its recent big run up. It closed within
a very short term downtrend and below a key Fibonacci support level, suggesting
more consolidation.
Bottom
line: the indices pushed higher this
week. While the momentum has been spectacular and they continue to push through
resistance levels, they are nearing an area of even heavier resistance. That is not to say that the uptrend can’t
continue; but it is likely to get a bit more labored. My assumption remains that they challenge
their all-time highs but fail to push above them.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17792)
finished this week about 43.1% above Fair Value (12432) while the S&P (2072)
closed 34.7% overvalued (1538). 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 US economic
data this week turned more upbeat again.
Of particular note was the improving trend in the manufacturing
sector. I don’t think that that
necessarily negates my recession call; but it sure enlarges the question mark. That said, the global economic data is
horrible; and if you don’t believe me, ask Janet Yellen. With the rest of world misfiring, I don’t see
how the US can escape the fallout.
Not helping
matters, oil prices reversed their recent strong uptrend. This may be just some consolidation after a
big run up. On the other hand, the April
OPEC meeting to freeze production is turning out to be sham, I had
expected---which likely puts the lack of financial viability of many oil
companies and the banks that serve them back on the table. And as I have noted several times, there is
currently little evidence to support higher oil prices. However, the linkage between oil prices and
stock prices seems to have lost, probably as a result of renewed investor
euphoria over Yellen’s dovishness.
In sum, even if our
forecast of recession is wrong, the economy is still growing at a snail’s pace
and faces a huge headwind from the rest of the world’s economies---which makes
most Street forecasts for the economy, corporate earnings and, hence, stock
valuations too high.
Fed policy remained
in the forefront of investors’ mind this week, as Yellen smacked her hawkish colleagues
‘up side the head’, putting future rates hikes on the back burner. As you know, I think that she is probably
correct in her assessment of global economy.
What continues to have me puzzled is that if she is so concerned about
it that she is afraid that a puny 25 basis point increase in the Fed Funds rate
would have a deleterious impact on the global economy, why is that an
investment positive? Yeah, I know, it
keeps money cheap so speculators can chase returns. But how much return is left when a huge
percentage of global fixed income securities are at a negative yield and stock
prices are near all-time highs as corporate earnings fall?
Someday, those
two questions will be answered. As I
noted last week ‘Clearly the operative
word in that statement is ‘when’. Based
on my record of late, I don’t have a clue ‘when’ is. I only note that the more the Fed pursues
this dovish/hawkish double talk, the more likely the ‘when’ is sooner rather
than later. Unfortunately, as long as investors’
ill-conceived euphoria lasts, mispriced assets will remain in nosebleed
territory.’
Another must
read from Doug Kass (medium):
When it does end,
I believe that the cash generated by following our Price Discipline will be
welcome as investors wake up to the Fed’s (and other central bank) 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.
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.
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 4/30/16 12432
1538
Close this week 17792
2072
Over Valuation vs. 4/30 Close
5% overvalued 13053 1614
10%
overvalued 13675 1691
15%
overvalued 14296 1768
20%
overvalued 14918 1845
25%
overvalued 15540 1922
30%
overvalued 16161 1999
35%
overvalued 16783 2076
40%
overvalued 17404 2153
45%
overvalued 18026 2230
Under Valuation vs. 4/30 Close
5%
undervalued 11810
1458
10%undervalued 11188 1384
15%undervalued 105678 1307
* 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.
