The Closing Bell
10/25/14
Statistical Summary
Current Economic Forecast
2013
Real
Growth in Gross Domestic Product:
+1.0-+2.0
Inflation
(revised): 1.5-2.5
Growth
in Corporate Profits: 0-7%
2014
estimates
Real
Growth in Gross Domestic Product +1.5-+2.5
Inflation
(revised) 1.5-2.5
Corporate
Profits 5-10%
2015
estimates
Real
Growth in Gross Domestic Product +2.0-+3.0
Inflation
(revised) 1.5-2.5
Corporate
Profits 5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Downtrend (?) 15702-16782
Intermediate Trading Range 15132-17158
Long Term Uptrend 5148-18484
2013 Year End Fair Value
11590-11610
2014 Year End Fair Value
11800-12000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Downtrend (?) 1796-1927
Intermediate
Term Trading Range 1740-2019
Long Term Uptrend 771-2020
2013 Year End Fair Value 1430-1450
2014 Year End Fair Value
1470-1490
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 47%
High
Yield Portfolio 53%
Aggressive
Growth Portfolio 49%
Economics/Politics
The
economy is a modest positive for Your Money. Though
slow, this week’s economic data was again weighed to the positive side: positives---weekly
mortgage applications, September existing home sales, September leading
economic indicators and the September Chicago Fed National Activity Index;
negatives---weekly purchase applications, the October Markit flash PMI, the
combo of revised August new home sales and September new home sales and October
Kansas City manufacturing index; neutral---weekly retail sales, weekly jobless
claims and September CPI.
While the volume
of this week’s data leaned negative, the plus primary indicators (September
existing home sales, September leading economic indicators) outnumbered the
minus’ (August/September new home sales) two to one. Tilting the balance even further to the
positive is the fact that existing home sales (a plus) are about ten times the
number of new home sales (a minus). Nonetheless, however hopeful these stats,
this is only the second week in which they have been a net positive; and even
then, I would not characterize the readings as robust. So it is way too soon to be rejoicing about an
overall improvement in the data.
In addition,
while the statistics from overseas weren’t as bad as they have been, they were
still mixed at best. As a result, a
slowdown in the global economy still ranks as the number one threat to our
forecast.
That said, the
modest improvement in the dataflow over the last two weeks does lead to the
question, are the more upbeat stats marking the beginning of an improvement in
the economy (ies) or are they just a pause before another onslaught of lousy numbers
resume?
The answer is
that I don’t know; so the point is that (1) much more information is needed
before I can feel comfortable that the economy isn’t losing steam, (2) but at
least I am questioning whether or not a slowdown is inevitable.
In short, our
outlook remains the same, and the primary risk (the spillover of a global
economic slowdown) remains just so.
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, 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 pluses:
(1)
our improving energy picture. The US
To date, this
rising supply has led to a fairly dramatic decline in energy prices. Initially, consensus was that this was a
major positive in that it served as a tax cut to consumers and a lower cost of
production for industry---which was absolutely correct. However of late, as global economic activity
slows, concern is growing that lower prices may be suggesting potential
recession. In short, this positive
appears to be transitioning into a double edged sword.
The
negatives:
(1) a
vulnerable global banking system. This week, a Spanish source reported that
eleven banks in six countries have failed the ECB stress test [the ECB will
announce results on Sunday]. The article
below suggests that the problem may be larger than that and is a must read:
And it was
revealed that the NY Fed knew about the London whale well before the disaster:
2007 redux
(medium):
‘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 a collapse of the EU financial system.’
(2)
fiscal policy. As
you know, the elections approach and the polls are telling us that the
republicans will keep the House and win control of the Senate. Many believe that this will somehow be a plus
for fiscal policy---the assumption being that the GOP is more fiscally responsible
than the dems. Pardon my skepticism but
that simply can’t be supported by the facts from the last two decades.
Sure, the
rhetoric is there. Yes, the Tea Party
has had an impact on policy positions.
But I am waiting for some proof before giving the GOP a gold star for
fiscal responsibility; hence, I think caution is the word in anticipating some
conservative fiscal renaissance.
Of course, even
if the republicans’ hearts are in the right place, it may make no difference
initially because Obama can veto any measures not sufficiently
‘progressive’. The good news is that if
a standoff occurs, it will be the dems/Obama this time that get tarred with the
obstructionist brush.
I think that
the most likely outcome will be gridlock which itself, I think, is a
positive---witness the decline in the budget deficit the last two years. That said, this country needs tax and
regulatory reform to boost its secular growth rate and those measures will
likely remain nothing more than wishful thinking until at least 2016.
(3)
the potential negative impact of central bank money
printing: The key point here is that [a] the Fed has inflated bank reserves
far beyond any comparable level in history and [b] while this hasn’t been an
economic problem to date, {i} it still has to withdraw all those reserves from
the system without creating any disruptions---a task that I regularly point out
it has proven inept at in the past and {ii} it has created or is creating asset
bubbles in the stock market as well as in the auto, student and mortgage loan
markets.
The major news
item this week was the rumor, twice denied, that the ECB, as part of their new,
improved QE, would begin buying corporate debt in the near future. Even assuming that is true, a study [linked
to in Thursday’s Morning Call] suggests that the universe of possible purchase
candidates is so small, that this program would have virtually no impact [oh darn, back to the drawing board].
Not that it
would make a difference if the numbers were substantially larger. As I keep documenting, QE [except for QEI]
hasn’t worked anywhere in any amounts; and there is no reason to assume it
would in this case. In particular,
coming as it does on the heels of Draghi’s admission that economic conditions
in the EU aren’t going to improve until fiscal reform takes place.
Speaking of
fiscal reform, we got another stunning bit of news this week, to wit, the IMF
stated that it approved of the second round of Japanese tax increases. So let me get this right. The Japanese economy is sinking like a stone
and a tax increase is just what the doctor ordered to kick start activity.
No more comment
needed.
(3)
geopolitical risks. Two items of note this week: (1) the
Russian/Ukrainian negotiations regarding the pricing of gas this winter fell
apart. Not particularly
surprisingly. Putin has made it clear
that he will not be intimidated by US/EU sanctions and will respond in
kind. That suggests higher gas
prices/lower supplies to the EU/Ukraine this winter; and that’s not likely to
make for great headlines, (2) a Canadian of Algerian decent, who had converted
to Islam, shot and killed a soldier.
This is the second such incident in Canada in as many weeks and raises
the potential of stepped up terrorist activity outside the Middle East.
(4)
economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. For the first time in a
while, the economic news out of the rest of the world was at least mixed. That hardly means a turnaround, but we have
to take positive news where we get it.
At the moment, I don’t think it means much more than that the slide into
recession is not a straight line; but my hope is that it marks the beginning of
a bottoming in economic activity. So I
remain alert to further data.
My hopes aside,
the facts on the ground are that the global economy continues to struggle just
to stay flat. So at this moment, there is little to assuage my concerns over
continued deterioration in global economic activity and that drives me to the
conclusion that global recession is the number one risk to our economy.
The slowdown in China’s growth (medium):
Bottom line: the US economy finally showed some signs of
improvement, however paltry. Likewise,
the data from Japan, China and Germany, three of our major trading partners, provided
a modicum of hope that their economies might be stabilizing. Of course, one week’s stats are hardly
something on which to hang that hope; so it does little to lessen my concerns.
Unfortunately,
there hasn’t been the slightest hint that the global economy will receive any
help from changes in either monetary or fiscal policies. Yes, the US has elections very shortly that
could alter the balance of power in congress; but that may mean little if Obama
hunkers down and refuses to compromise.
As for Europe, France, Italy and Germany have all let it be known that
they have no intent in following suggested fiscal reforms suggested by the ECB. As for monetary policy, it remains
QEForever, its continuing lack of success notwithstanding.
Geopolitically,
the world is a mess. The standoff in
Ukraine has clearly not been resolved; and winter (i.e. the need for gas) is
rapidly approaching. The ground action
in Syria/Iraq is going against us; and this week, the war got a little closer
to home. True it was Canada, not the US;
and the terrorist was homegrown versus imported. But that will be of little consolation if we
wake up to similar headlines here.
In sum, the both
the US and EU economies showed signs of improvement this week, though we need a
lot more of that to feel comfortable that the global economy is not going to
pull us into recession.
This week’s
data:
(1)
housing: weekly mortgage applications were up but
purchase applications were down; September existing home sales were much better
than anticipated; September new home sales were also up but the August number
was revised down hugely,
(2)
consumer: weekly
retail sales were mixed; weekly jobless claims rose less than estimates,
(3)
industry: September Chicago Fed National Activity Index
was much better than forecast expectations; the October Markit manufacturing
flash PMI was below forecast as was the Kansas City Fed October manufacturing
index,
(4)
macroeconomic: September leading economic indicators
were stronger than anticipated; September CPI was slightly more than forecast.
The Market-Disciplined Investing
Technical
The
indices (DJIA 16805, S&P 1958) gave us another wild ride this week. The Dow finished above the upper boundary of
its short term downtrend (15702-16782) on Friday; if it remains above that
level through the close on Tuesday, the trend will re-set to a trading range. It also ended within an intermediate term
trading range (15132-17158), a long term uptrend (5148-18484) and below its 50
day moving average.
The S&P closed
above the upper boundary of its a short term downtrend (1796-1927) for the
second day; if it ends there on the bell Monday, the trend will re-set to a
trading range. It also finished within
an intermediate term trading range (1740-2019), a long term uptrend (771-2020)
and below its 50 day moving average.
Volume declined;
breadth was mixed. By one measure, the
Market is again dramatically overbought. The VIX fell, ending within a short
term uptrend, an intermediate term downtrend and above its 50 day moving
average.
The long
Treasury rose on Friday, closing within a very short term trading range, a
short term uptrend, an intermediate term trading range and above its 50 day
moving average.
GLD was down on
Friday. It broke its very short term
uptrend this week, re-setting to a trading range. It remained within short and intermediate
term downtrends and below its 50 day moving average.
Bottom line: equities
recovered smartly this week; but did so with stunningly schizophrenic volatility. Many of the indicators that we follow daily
made multiple trend changes in those five days despite the smoothing effect of
our time and distance discipline. I am
at a point where I feel completely out of touch with Market sentiment. When I am,
it is always best to do nothing.
Nonetheless, I would use any rise in prices to Sell stocks that are near
or at their Sell Half Range or whose underlying company’s fundamentals have
deteriorated.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (16805)
finished this week about 42.0% above Fair Value (11829) while the S&P (1958)
closed 33.3% overvalued (1468). 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 slightly
more upbeat economic dataflow both here and aboard hardly seemed sufficient to
warrant the euphoria we witnessed in equities.
But when combined it with last week’s souped up QE comments from the
global central bankers, investors were provided with a goldilocks scenario (an
improving economy and an easier Fed) to discount. Not that I think this will happen. Investors just don’t seem to get that they
can’t have it both ways. If the global economy
is suddenly healing, QE is terminal. If
it is slipping into recession, QE/the central banks are going to get pilloried for
not stimulating growth. But I suppose
that is tomorrow’s problem.
In the end, as I
have been insisting for a long time, this is not about the economy in any
case. It is about asset mispricing which
(excluding the stick save of QEI) appears to have been the major result of
global QEInfinity. Clearly, markets are
still intoxicated by the prospect of more free money; but at some point, the
realization will set in that it has totally failed to generate the outcomes
promised by the central bankers and so widely anticipated investors. Whenever that happens, I believe that
valuations will retreat to more sensible levels.
Fed’s grand
illusion
The farce of European
stocks (short):
Geopolitics
re-emerged this week as a possible source of Market heartburn. Russia and Ukraine couldn’t agree on a
pricing contract for winter gas. Hardly
surprising. I guess that I don’t have to
point out who has the hammer in any negotiations; and if nothing gets done, it
will be a tough winter in euroland.
In addition, the
war in the Middle East has made its way to the Western Hemisphere with the two
incidents in Canada. That doesn’t mean
that the US will get hit; but it suggests that the odds aren’t zero.
Overriding all of these considerations is
the cold hard fact that stocks are considerably overvalued not just in our
Model but with numerous other historical measures which I have documented at
length. This overvaluation is of such a
magnitude that it almost doesn’t matter what occurs fundamentally, because there
is virtually no improvement in the current scenario (improved economic growth,
responsible fiscal policy, successful monetary policy transition) that gets
valuations to Friday’s closing price levels.
Bottom line: the
assumptions in our Economic Model haven’t changed (though our global ‘muddle
through’ scenario is at risk). The
assumptions in our Valuation Model have not changed either. I remain confident in the Fair Values calculated---meaning
that stocks are overvalued. So our
Portfolios maintain their above average cash position. Any move to higher levels would encourage
more trimming of their equity positions.
I
can’t emphasize strongly enough that I believe that the key investment strategy
today is to take advantage of the current high 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 and
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 2014 Year End Fair Value*
11900 1480
Fair Value as of 10/31/14 11852 1472
Close this week 16805
1958
Over Valuation vs. 10/31 Close
5% overvalued 12444 1545
10%
overvalued 13037 1619
15%
overvalued 13629 1692
20%
overvalued 14222 1766
25%
overvalued 14815 1840
30%
overvalued 15407 1913
35%
overvalued 16000 1987
40%
overvalued 16592 2060
45%overvalued 17185 2134
Under Valuation vs. 10/31 Close
5%
undervalued 11259 1398
10%undervalued 10666
1324
15%undervalued 10074 1251
* 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 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.
