11/14/15
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 1957-2749
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 solidly negative: above estimates: weekly purchase applications,
September wholesale inventories and sales and November consumer sentiment;
below estimates: weekly mortgage applications, month to date retail chain store
sales, October retail sales, the October small business confidence index,
October import/export prices, the October budget deficit and October PPI; in
line with estimates: weekly jobless claims and the September business
inventories/sales combo.
If there is any
bright spot in this otherwise downbeat week, it is that there was only one
primary indicator: October retail sales.
The bad news is that it was negative.
While the recent
back and forth in economic numbers from negative to positive and back again may
be indicating that the economy could be stabilizing at a still lower (than
originally forecast) rate of growth, it provides little evidence of any
uptick. On the other hand, it is hopefully
a sign that recession is less likely.
That said, see saw data over a four week timeframe is just enough to
make matters confusing. For the moment, I
am sticking with our current forecast; but a dramatic change in the data one
way or the other could lead to a third modification in our outlook.
Weighing on our
economic prospects is the continuing stream of poor data from abroad---from all
our major trading partners: Canada, China and Europe. Not helping is Greece sliding toward another
economic/political crisis; and it could be joined shortly by Portugal.
The above
notwithstanding, investors eyes remained glued to Fed this week attempting to
decipher whether or not a December rate hike is in the cards. Indeed, most of the economic data was being analyzed
in terms of its impact that Fed decision.
Of course, based
on this week’s numbers, one might assume a lesser chance of a rate hike. But since the Fed is not ‘data dependent’,
and since the Market was doing fine up until Thursday, and since the Fed is
really ‘Market dependent’, on Thursday, the Fed executed a double hat trick
when six of its officials all suggested that it was on track for a rate
hike---again, the above data notwithstanding.
As I observed in Friday’s Morning Call: ‘six Fed
officials spoke yesterday and, overall, they did nothing to alter the view that
a December rate hike is coming---which suggests that [a] either they aren’t
paying attention to (1) above {the lousy stats here and abroad} or [b] as I have proposed, they have made
their minds that they have to raise rates because it will be easier to argue
that they were too late to raise rates due to an overabundance of caution than
to have to defend themselves for having completely missed the opportunity to
normalize monetary policy.----again.
In summary, the US
economic stats may be showing signs of stabilizing while the international data
remains sub-par. 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.
The
negatives:
(1)
a vulnerable global banking system. There was a concerning news item this week,
relating to the solvency of the Chinese banking system. The Financial Stability Board said that
Chinese banks could be undercapitalized by as much as $400 billion under new
global capital requirements.
Here is a summary
of the steps being taken to curb the risks of ‘too big to fail’ banks (medium
and a must read):
Clearly, these measures are a long term plus for the
world’s financial system. There is a
short term risk that many banks’ equity are still well below requirements and
the time to correct that deficiency is long enough, that another liquidity
event could occur [I am thinking of China, in particular] and do its damage in
the interim.
Or will there be mass bankruptcies in the energy space?
(short):
Corporate leverage at record levels (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 in the international financial
system.’
(2) fiscal/regulatory
policy. Quiet week.
(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.
QE keeps
getting support on a global basis. This
week Draghi et al made not one, not two, but three pretty strong statements
about the likelihood of additional ease from the ECB.
On the other
hand, the noise out of the Fed continues to sound hawkish. Whether it will hold that line in the face of
so so economic data here and really rough numbers abroad is the $64,000
question. Of course, if you believe
Bullock’s statement last week that even if the jobs’ figures weaken, the rate
hike is still on the table, then it is coming.
That said, this
group of eggheads are scared sh**less of the consequences of their
irresponsible monetary policy and if the Market starts getting whacked, they
could very well chicken out of increasing rates.
My thesis is:
[a] QE {except
QEI} has had a negative impact on the economy; so unwinding it will have a
positive effect on the economy,
[b] however, QE
led to significant asset mispricing and misallocation; unwinding it will have
an equally significant effect on asset prices,
[c] in any
case, the Fed has once again waited too long to begin the process on monetary
normalization. Indeed, if they go through
with the December rate hike, it will be raising rates in the midst of a
slowdown in economic growth,
[d] the Fed
knows that it has made a mistake, but appears to think that its only
alternative is to bulls**t the Markets and pray for luck. The danger here is that in a desperate
attempt to extricate itself from the problem, it may make another equally
disastrous misjudgment and only make matters worse. (must read):
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: the political landscape in the Middle East remains as Byzantine as
ever. There are so many players with so
many conflicting agendas, that any move by any one player is going to gore
somebody else’s ox.
I am not worried about who is killing who in
this war. As far as I am concerned, the
US is a net winner in any case. However,
the more players and the more pervasive their presence, the greater the odds of
an ‘accidental’ confrontation that could lead to something much bigger.
I am also
uneasy about the continuing erosion of respect accorded to the US. Weakness is not a quality admired by our
major adversaries and could lead them to pursue even more aggressive anti-US
policies.
Given the
cluelessness of our current foreign policy, the risks exist of either [a]
further humiliation which will be difficult for the next administration to walk
back or [b] an inappropriate US response in an attempt to prove it has
cojones. While I have no idea about the
odds of either transpiring, they are not zero and that makes me a bit nervous.
(5) economic
difficulties in Europe and around the globe. This week’s overseas economic stats continued
an awful string of releases: October
Chinese exports fell while imports dropped precipitously; Chinese CPI, PPI,
industrial production and urban fixed investment were all below expectations;
however, retail sales were better than estimates; German exports were better
than forecast; third quarter EU GDP was below consensus; Japanese machinery
orders were above forecast.
In related
news, Canada [one of our largest trading partners] appears to be slipping into
recession; the OECD lowered its global growth estimates for 2015 and 2016; several
members of the ECB said that there was growing consensus to push interest rates
further into negative territory; the Financial Stability Board said that
Chinese banks may need as much as $400 billion new equity in order to meet new
global capital requirements.
In ecopolitical
news,
[a] Greece and
its EU creditors are in a dispute over implementation of reforms, delaying the
latest tranche of bail out funds; and now the Greeks are in the street,
[b] Portugal’s
newly formed government was brought down by a coalition that wants to reverse
[EU imposed] austerity measures. Greece
part two?
Finally, one
additional piece of anecdotal evidence: base metals now down 50% off 2011
highs.
So the
international data remains poor, especially that coming out of China---which,
as I noted last week, is the 800 pound gorilla lurking in the weeds. And aside
from the lousy numbers, the FSB says that their banks are woefully
underfunded.
Add to that the
potential problems in Greece and Portugal and the global economic risks seem to
be growing.
Counterpoint (medium):
As a result, this
keeps the yellow flashing on our global ‘muddling through’ assumption; but 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. In addition, 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.
As you know, I recently
lowered our economic forecast for a second time. And while I may have to do so again, the data
from the last four weeks provides the hope that I may not and that recession is
off the table.
A deteriorating
global economy and a counterproductive central bank monetary policy are the biggest
economic risks to our forecast.
This week’s
data:
(1)
housing: weekly mortgage applications fell, while
purchase applications were up slightly
(2)
consumer: month to date retail chain store sales dropped
precipitously from the prior week; October retail sales were well below
consensus; weekly jobless claims were unchanged; the preliminary November
consumer sentiment index was above forecasts,
(3)
industry: the October small business optimism index was
below expectations; September wholesale inventories grew more than estimated as
did sales; September business inventories were up more than projected, but
sales were flat,
(4)
macroeconomic: October PPI was dramatically lower than
anticipated; October import prices were well below consensus while export
prices were slightly lower; the October budget deficit was up versus the prior
year.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 17245, S&P 2023) took a second body blow yesterday. The Dow ended [a] above its 100 moving
average, which represents support, [b] below its 200 day moving average for a
second day, now support; if it remains below this MA through the close next
Tuesday, it will revert to resistance, [c] within a short term trading range
{16919-18148}, [c] in an intermediate term trading range {15842-18295} and [d]
in a long term uptrend {5471-19343}.
The S&P
finished [a] below its 100 moving average, which represents support; if it
remains there through the close on Tuesday, it will revert to resistance, [b]
below its 200 day moving average for a second day, now support; if it remains below
this MA through the close next Tuesday, it will revert to resistance, [c] in a
short term trading range {2016-2104}, [d] in an intermediate term uptrend
{1955-2747} [e] a long term uptrend {800-2161}.
Has the post-crash
rally run its course (medium)?
Volume rose;
breadth was mixed---a little unusual for such a negative price day. The VIX (20) was up 9%, ending [a] above its
100 day moving average, now resistance; if it remains there through the close
on Tuesday, it will revert to support, [b] above the upper boundary of its a
short term downtrend; if it remains there through the close on Tuesday, it will
re-set to a trading range and [c] in intermediate term and long term trading
ranges.
The long
Treasury rose (not really indicative of fear of rising interest rates),
remaining below its 100 day moving average, now resistance but within very
short term, short term and intermediate term trading ranges.
GLD was down,
ending [a] below the lower boundary of its short term trading range; if it remains
there through the close on Tuesday, it will re-set to a downtrend, [b] below
its 100 day moving average, now resistance, [c] in intermediate and long term
downtrends.
Bottom line: multiple
indices are now challenging multiple support levels. Clearly, underlying investor sentiment began
to swing dramatically on Thursday and Friday.
As always, more follow through its required before we can assume a
change in momentum. If the decline
continues, it would be a very negative signal for the long term direction of
the Market (the Averages have unsuccessfully tested their highs three times
then fell short on their fourth attempt).
A rebound above the most recent high would likely portend a challenge of
the indices all-time highs and the upper boundaries of their long term
uptrends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17245)
finished this week about 40.5% above Fair Value (12267) while the S&P (2023)
closed 33.0% overvalued (1521). 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 may be stabilizing, signifying a leveling out at a lower rate of growth;
but then again, given this week’s stats, it may not be. At
this point, it is too soon conclude whether the last four weeks are just a
pause in a decline or if the economy is steadying. Although hopefully it is a
sign that a recession is not in the offing.
Unfortunately,
the global economy remains a mess and it’s not being helped by growing political
turmoil in Europe---and that in turn makes it all the more difficult for the US
to continue to grow.
In sum, the US economic
picture is a bit muddy 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 not
the least bit murky---it is crappy. 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, the Fed
kept up with the hawkish comments, becoming ever more convincing that a
December rate hike is likely. Perhaps
more important than whether or not the Fed does raise rates, is what it is
doing to its own credibility. The cold, hard facts, as I see them, are that the
Fed (1) has pursued a policy that has created another asset bubble, (2) it has
waited too long to attempt to correct that mistake---as it has in every single
other attempt it has made to transition from easy to normal monetary policy,
and (3) its only choices are to do the right thing [i.e. return to a normalized
monetary policy], which will be painful, or to continue to pursue a disastrous
strategy hoping and praying for a miraculous way out, which I believe will end
even more painfully when hope and prayer prove an empty strategy.
In either case,
sooner or later, investors are going to figure out the corner in which the Fed has
placed the economy and Market---and it probably won’t enhance its
reputation.
However, whenever and whatever happens, I believe
that the cash generated by following our Price Discipline will be welcome when
investors wake up because I suspect the results will not be pretty.
Net, net, my two
biggest concerns for the Markets are (1) the economic effects of a slowing
global economy and (2) Fed [central bank] policy actions whatever they are or
are not and the loss of confidence in those actions.
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 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) 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 2015 Year End Fair Value*
12300 1525
Fair Value as of 11/30/15 12267
1521
Close this week 17245
2023
Over Valuation vs. 11/30 Close
5% overvalued 12880 1597
10%
overvalued 13493 1673
15%
overvalued 14107 1749
20%
overvalued 14720 1825
25%
overvalued 15333 1901
30%
overvalued 15947 1977
35%
overvalued 16550 2053
40%
overvalued 17173 2129
45%
overvalued 17787
2205
50%
overvalued 18400 2281
Under Valuation vs. 11/30 Close
5%
undervalued 11653
1444
10%undervalued 11040 1368
15%undervalued 10426 1292
* 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.
