Saturday, September 29, 2012

The Closing Bell--Nothing's changed

The Closing Bell


Statistical Summary

   Current Economic Forecast


Real Growth in Gross Domestic Product (revised):        +1.0- +2.0%
                        Inflation (revised):                                                             2.5-3.5 %
Growth in Corporate Profits (revised):                   5-10%


                        Real Growth in Gross Domestic Product                       +1.0-+2.0
                        Inflation                                                                           2.0-2.5
                        Corporate Profits                                                              0-7%

   Current Market Forecast
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Uptrend                               13265-14035
Intermediate Up Trend                            12457-17457
Long Term Trading Range                      7148-14180
Very LT Up Trend                                       4546-15148        
                        2011    Year End Fair Value                               10750-10770

                        2012    Year End Fair Value                                     11290-11310

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Up Trend                                     1415-1505
                                    Intermediate Term Up Trend                     1312-1912 
                                    Long Term Trading Range                        766-1575
                                    Very LT Up Trend                                         651-2007

                        2011    Year End Fair Value                                      1320-1340         

                        2012    Year End Fair Value                                      1390-1410

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                              24%
            High Yield Portfolio                                        25%
            Aggressive Growth Portfolio                           27%

The economy is a modest positive for Your Money.  The economic data this week was basically negative highlighted by an especially lousy durable goods number.  Positives: weekly retail sales, consumer confidence, weekly jobless claims, weekly mortgage and purchase applications and the September Richmond Fed manufacturing index.  Negatives: the Chicago national activity index, the Dallas Fed manufacturing index, the Case Shiller home price index, August new home sales, August durable goods orders, Chicago PMI, the University of Michigan’s final September consumer sentiment index, August personal income and the revised second quarter GDP figure  Neutral: August personal spending and core PCE. 

This is the second week in a row of overall disappointing stats; and as I noted above, particularly distressing was the durable goods report.  On the other hand, Friday’s personal income and spending numbers were up---and remember that the consumer is 75% of the economy.  Two weeks of poor data certainly don’t mean a recession is on its way; but it is cause to raise the alert level to amber.  For the moment, I am not altering 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)   talk about bad timing.  I pulled the recession call of the ECRI from our list of risks last week on the thesis that not only had it not had declined in seven weeks [in fact, it was up again this week], its founder’s predictions notwithstanding, but also because the ‘big four’ measures of the economy were showing little sign of recession.  Well, this week’s review of that indicator is now suggesting a risk that the economy could be stumbling.  It is not making a recession call, but the new readings clearly adds weight to elevated alert status I mentioned above.  Of course, this may be just a hiccup.  Nevertheless, it does start moving  this ‘plus’ factor towards  ‘neutral’.

(2) the seeming move of the electorate towards embracing fiscal responsibility.  I have argued that means a Romney/Ryan November victory which should be more conducive to fixing the monetary/fiscal/regulatory problems that plague this economy than an Obama win.  Unfortunately, Romney had another poor week campaigning; and if he doesn’t get his s**t together and quickly, he is going to default this election to Obama.  Hence, this factor is fading as a positive.
     The latest intrade results (short):

Notice how both our positives on the economy are becoming less so.  This doesn’t help my mood, improve my outlook for the economy or make me want to own more stocks.

The negatives:

(1) a vulnerable banking system.  More details regarding the Libor rate setting scandal came out this week.  By itself, this transgression is not going to sink the banks; but it is symbolic of the greed and disregard for the rules that has typified the financial industry for the last decade.  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) a blow up in the Middle East.  The Syrian civil war grinds on; and Israel and Iran seem headed for a face-off.  This week the focus was less on the risk of an act of war and more on Obama’s inept handling of the attacks on our embassies.  What is alarming is His refusal to admit/accept that Western civilization is in an existential struggle with radical Islam.  That only encourages more aggressive behavior by jihadists as their perception grows that the US is a paper tiger. 

I am not sure where that all leads; but I am reasonably sure that it won’t be to a more stable Middle East.  If that is the case, then one of the consequences is almost assuredly higher oil prices which, at the least, will act as a hindrance to US expansion and, at the worse, could well push the economy into recession and/or add fuel to inflationary impulses.

(3) now that the harvest season is in full swing, the focus on weather generated  commodity/food inflation seems to be waning.  Grain prices have flattened out but remain well above levels of six months ago while meat prices are flat and in some cases down.  That said the lower meat prices are a function of the premature slaughter of animals due to high feed costs; and that ultimately will lead to higher meat prices.

(4)   ‘another week, nothing done on the ‘fiscal cliff’ and no prospects anytime soon.  As you know, my position on the ‘fiscal cliff’ as it currently exists is that in the end, the scheduled tax increases and spending cuts will not occur; or if they do, they will be quickly reversed.  Whoever wins in November will do something in January to alter this outcome---we just don’t what that will be.

That said, the risk here is that the above assessment is dead wrong; that is, we once again end up with a split government, both parties decide to play chicken and push the US over the cliff waiting for the other party to blink.

The other problem which I introduced several weeks ago is the potential rise in interest rates and their impact on the fiscal budget.  As I noted, 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.  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 a 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 it 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.

In the meantime, the inability of our political class to focus on anything but its own re-election contributes to the fear and uncertainty among businesses and consumers and by extension their willingness to spend, invest and hire.’

                  Pimco on the ‘fiscal cliff’ (medium):

(5)   rising inflation: the potential negative impact of central bank money printing.  Draghi and Bernanke went ‘all in’ for monetary easing a couple of weeks ago.  Japan joined the parade last week, followed by China this week.  That puts the central bankers in a contest of competitive devaluations.

The risk of a massive global liquidity infusion is, of course, inflation.  The bulls argue that thus far, all this money has gone into bank reserves [meaning it has not been spent or lent], that as long as banks are too scared to lend and businesses to borrow, it will remain unspent and unlent and therefore will have no inflationary impact.  And they are absolutely correct.  But the whole point of the Fed’s exercise is to encourage banks to lend and businesses to invest.  So on the off chance that plan works, inflationary pressures will grow unless the Fed withdraws the aforementioned reserves before inflation kicks in.

And therein lies the rub.  [a] Bernanke has already said 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.  Why will this time be any different?

(7)   finally, the sovereign and bank debt crisis in Europe remains the biggest risk to our forecast.  This week was marked by riots in Spain and Greece protesting austerity.  Undaunted both Spanish and Greek politicians devised another plan to meet the demands of the EU for a further bail out.  Like every other plan offered up in the past, these contained some Herculean assumptions about future growth which don’t have a snowball’s chance in hell of occurring; thus guaranteeing yet another round of austerity demands in order to qualify for yet another bail out.

Of course, as long as voters and investors go along with this charade, a ‘muddle through’ scenario will remain operative.  Unfortunately, there are a number of problems: [a] the continent by all measures is slipping into recession; and that will make it all the more difficult for the eurocrats to make credible economic growth assumptions that investors and voters will swallow, [b] this week’s protests suggest that the unwashed masses have already had enough. If so, then time is running out on the eurocrats to come up with a real solution.

I believe that the above argues that the European ‘tail risk’ has not gone away as many investors now do.  That ‘tail risk’ is that investor patience wears thin and they trash the eurobond/eurocurrency markets, creating a crisis that is beyond the eurocrats’ capability to resolve---a likely outcome of which will be a freezing up of the entire financial system which infects our own [via counterparty risk in credit default swaps].

The latest from Spain (both medium):
Bottom line:  the US economy continues its sluggish progress, though it has definitely hit a bump in the road in the last two weeks.  I still believe that the US will avoid a recession although the amber lights are flashing on this assumption.

Not helping is the current hesitancy to spend and invest due to uncertainty over future regulatory and tax policies as well as the ‘fiscal cliff’.  This condition will likely remain unchanged until after the election; and even then could continue depending on the new balance of power.  In the meantime, the Fed is running the presses 24/7 adding daily to risk of future inflation.

Finally, the EU is doing what it does best which is lie to its citizens for the sake of preserving a bureaucratic wet dream.  I am not smart enough to know what happens next; but I do believe that unless the eurocrats get real with their citizens and their policies---and soon, the end will be uglier than I am now assuming. 

For the moment, this is all reflected in our Models.

This week’s data:

(1)                                  housing: both the weekly mortgage and purchase applications increased;  the July Case Shiller home price index was up but less than estimates;  August new home sales were below expectations,

(2)                                  consumer: August personal income was below forecast; both personal spending and core PCE were in line; weekly retail sales were up; weekly jobless claims declined more than expectations; September consumer confidence spiked higher but the University of Michigan’s final September reading of consumer sentiment was below both estimates and August’s report,    

(3)                                  industry: August durable goods orders were horrendous; the September Dallas Fed manufacturing index came in well below expectations while the comparable Richmond Fed’s index rose much more than anticipated; the September Chicago PMI fell dramatically,

(4)                                  macroeconomic:  second quarter GDP was up 1.3% though it was revised down from up 1.7%; the Chicago national activity index fell.   

The Market-Disciplined Investing

This week, the indices (DJIA 13437, S&P 1440) closed within two primary trends: (1) their short term uptrends [13265-14035, 1415-1505] and (2) their intermediate term uptrends [12457-17457, 1312-1912].  Resistance exists at the old 2007 highs of 14190/1576 and support at the April 2012 resistance turned support level of 13302, 1422.  The S&P traded below the 1442 minor support level for the second time on Friday.  That re-starts our time and distance discipline.

Volume on Friday rose while breadth declined.  The underlying technical strength of the Market continues to deteriorate with the flow of funds, on balance volume and our own internal indicator weakening again this week.  The VIX rose but remains below the upper boundary of its short term downtrend and above the lower boundary of its intermediate term trading range. 

More divergences (short):

GLD was down fractionally, finishing above the lower boundaries of its (1) very short term uptrend, (2) short term uptrend and (3) intermediate term trading range. The recent move up has brought GLD close to the 175.5 upper boundary of the intermediate term trading range.
            Bottom line:

(1) the DJIA and S&P are in uptrends, both in the short term [13265-14035, 1415-1505] and the intermediate term [12457-17437, 1312-1912],

(1)   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. 

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (13437) finished this week about 20.0% above Fair Value (11165) while the S&P (1440) closed 4.2% overvalued (1382).  Incorporated in that ‘Fair Value’ judgment is a ‘muddle through’ scenario in Europe and a sluggish recovery at home that isn’t likely to improve until we change the personnel in Washington.

The economy continues its slow. plodding progress---although this week made the second in a row of disappointing data.  This is too short a timeframe to warrant altering our forecast but not too soon to be on heightened alert.

As you know, I have been hopeful that the chances of ‘a change in personnel in Washington’ was a possibility this November.  As you also know, that hope has been fading of late as the Romney camp proves over and over again that it is not ready for prime time.  As much as I dislike Obama’s policies, I have to give Him and his media sycophants credit for controlling the debate---at least to date. 

Of course, it is never over till its over.  But if the electorate chooses a nanny state over a capitalist one, then our short term forecast (higher taxes, higher government spending, more regulation and an activist monetary policy) will transition into a long term outlook.  That means slower economic growth and a less friendly environment for Your Money.  To be sure, large corporations (and hence their earnings) may do just fine.  After all, they have plenty of money to rent seek from an increasing receptive political class.

But that doesn’t necessarily translate to a positive for Your Money.  That is the reason that I have began investigating strategies for survival.  I am doing nothing different (to some extent our GLD and foreign ETF positions already reflect my concerns) until we know the November election results.  But if Obama wins, my efforts will become much more active.

         All that said, the probability of severe economic dislocations in Europe remains the biggest risk in our forecast.  Investor euphoria over Draghi’s new ‘all in’ policy notwithstanding, I am not sure how much has really changed nor that any ‘tail risk’ has been removed.   Supporting that notion, this week (1) the Spanish parliament came up with an austerity plan that on the surface meets EU standards but mathematically is more of the same---make promises that you know you can’ keep, fail, make more promises that you can’t keep, fail again, rinse and recycle, (2) Spain erupted in protests and the Catalonia region joined Basque threatening to secede, (3) Greece failed to meet its latest austerity goals, appealed for more money, made some more promises that it won’t keep and as a just reward had to contend with more rioting.

         I don’t know about you; but after all that, I am hard pressed to assume that Draghi has the situation under control, that everyone is going to cooperate and the EU will live in fiscal harmonious bliss forever more. On the other hand, as long as most investors buy the pack of lies and delusions that the eurocrats are selling, ‘muddle through’ will be the operative scenario.  And as long as that occurs, it gives the eurocrats more time to develop and implement a real ‘muddle through’ solution. 

        Of course, the preceding pretty much describes our forecast; and given that outlook, our Model has the Market (as defined by the S&P) priced modestly overvalued. That would normally warrant a cash holding of around 15% but with a smaller GLD position.  So clearly, I have concerns---the primary being this European problem, in particular the ‘tail risk’ associated with the potential failure of the eurocrats to prevent any of the PIIGS outside of Greece from imploding and the economic downside should that occur.  As a result, our Portfolios are heavier in both cash and GLD than they might otherwise be.

       At the moment, that puts me on the wrong side of the Market.  But I believe that stocks are being driven by a false euphoria generated by the ‘all in’ of the major global central banks and that ultimately, in Gary Kaminsky’s words, ‘this thing is going to end ugly’.

          My investment conclusion:  stocks (as defined by the S&P) are overvalued (as defined by our Model).  I have no clue how long this will go on; but as long as it is driven by easy monetary policy, it is a Market that is too risky for me to play.

         To be clear, the economy is performing as I expected; as are corporate profits.   So in the absence of any of the risks enumerated in the Economics section manifesting themselves, I am not worried about the fundamentals.  My decision to not chase stocks is based strictly on price.  So all things remaining equal, if stocks drop 10-12% in price, our Portfolios will be Buyers.’

        This week our Portfolios added to their GLD position; while the High Yield Portfolio lightened up its holdings of NUS and KMB.

       Bottom line:

(1)                             our Portfolios will carry a high cash balance,

(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.  An investment in gold is an inflation hedge and holdings in other countries provide exposure to better growth opportunities.  However, the likelihood of a continued strengthening in the dollar argues for less emphasis on these investment alternatives over the intermediate term.

(3)                                defense is still important.

DJIA                                                    S&P

Current 2012 Year End Fair Value*                11300                                           1400
Fair Value as of 9/30/12                                   11165                                                  1382
Close this week                                                13437                                                  1440

Over Valuation vs. 9/30 Close
              5% overvalued                                 11723                                                    1451
            10% overvalued                                 12281                                                   1520 
            15% overvalued                             12839                                             1589
            20%overvalued                                  13398                                                     1658
            25% overvalued                                 13956                                               1727
Under Valuation vs. 9/30 Close
            5% undervalued                             10606                                                      1312
10%undervalued                                  10048                                                  1243    15%undervalued                             9490                                                    1174

* 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.

Friday, September 28, 2012

Santelli: Putting profits in your pocket

The latest crop report

Morning Journal--More problems with student loans

  News on Stocks in Our Portfolios
            Walgreen (WAG): FQ4 EPS of $0.63 beats by $0.07. Revenue of $17B.

Medtronic (MDT) agrees to pay $816M for China Kanghui, a provider of orthopedic implants in a deal that expands the U.S. company's presence in China. Medtronic's offer of $30.75/ADR represents a 22.5% premium to Kanghui close yesterday. Barclays analyst Jason Mann says Kanghui provides Medtronic with "access to thousands of hospitals...(in) the fastest growing orthopedic market."

Nike (NKE): FQ1 EPS of $1.23 beats by $0.11. Revenue of $6.67B beats by $260M. Shares -2.3% AH.

            Accenture (ACN): FQ4 EPS of $0.88 in-line. Revenue of $6.8B. Shares +0.4%


   This Week’s Data
            August personal income was up 0.1% versus expectations of up 0.2%; personal spending was up 0.5%, in line; core PCE (inflation) was up 0.1%, also in line.




Another problem lurking beneath the surface of student loans (short):

The Morning Call--It's a Bizzaro World

The Market

            The indices (DJIA 13456, S&P 1447) rallied yesterday, remaining within their (1) short term uptrends [13265-14025, 1413-1503] and (2) intermediate term uptrends [12441-17441, 1310-1910].  This move took the S&P back above the 1442 resistance turned support level after having violated it on Tuesday.  That leaves this support level in tact.

            Volume was off; breadth improved though on balance volume remains quite negative.  The VIX fell considerably one day after confirming the break above the upper boundary of its very short term downtrend.  However, the drop was not sufficient to take it back to that former trend line.  So the penetration was validated.  This index is still well below the upper boundary of its short term downtrend.

            GLD (172.1) bounced powerfully, leaving it above the lower boundaries of its very short term and short term uptrends as well as the intermediate term trading range.  It is approaching the upper boundary (175.5) the same trading range.

            Bottom line: yesterday’s pin action halted the three day downtrend and negated the break of the S&P 1442 support level; and it leaves the Averages in an uptrend.  I know that my thesis of a weakening internal market structure is (1) getting old and (2) likely irrelevant to most investors. 

Nevertheless as our Portfolios actions yesterday illustrate, more stocks keep trading into their Sell Half Ranges while still others are breaking major technical support.  This is just not the kind of Market in which I want to be buying stocks.  It can be argued that I should have been more aggressively buying stocks six months ago---and that is a valid criticism.  But being wrong six months ago is not a reason to be wrong today.  Therefore, I continue to focus on the Sell side, except for GLD.

            Citigroup index records high complacency (short):

            Market performance in the fourth quarter of an election year (short):

            Bullish sentiment shows a decline (short):


            Yesterday’s economic data did not paint a pretty picture.  While weekly jobless claims were down more the expected, second quarter (revised) GDP grew much less than originally reported and August durable goods orders were down right awful.  The two latter numbers point at a weakening economy, as does the balance of data reported thus far this week and as did the stats from last week.  Nevertheless, it is too soon to consider altering our Model although the alert lights are flashing yellow.

            GDP and capital goods orders (a bit long but worth the read):

            GDP per capita (medium):

            That said, only in a bizzaro world could investors decide to ignore these negatives and instead choose to get jiggy about:

(1)     China joining the global money easing party.  I have dwelt on this issue ad nauseum and how the ongoing printing of money may be a ‘nose hit’ short term but will end very badly.  In addition, recent history has shown that the time period and magnitude of advance of the liquidity ‘high’ from each successive ‘nose hit’ keeps getting shorter and rising less.  Indeed, the euphoric reception given Bernanke’s ‘all in’ statement lasted seven trading days.   I can only wonder how long the Chinese ‘nose hit’ will last, especially given that we can’t trust anything these guys tell us.

(2)     more eurocrat smoke blowing out of Spain.  Ostensively, the Spanish parliament imposed more stringent austerity measures than the EU would have demanded in order to receive a bail out.  In other words, Spain met the conditions before they were even imposed, thus assuring a bail out. 

Not to toss too much cold water on this deal, but as I understand it:

     [a] Spain will impose several new measure meet the EU austerity demands

     [b] it plans new laws to bolster economy,

OK, so far so good; but now comes the good part:

[c] in meeting the goals of austerity, Spanish authorities assume GDP will fall by 0.5%.---to which I ask, what are those guys smoking?  With a soaring unemployment rate and the entire continent falling into recession, that simply makes no sense.  But of course, we know that because this is like every other eurocrat wet dream---it will never happen and will insure that Spain will follow Greece in serial misses of its austerity goals

[d] and this doozy, the country will tap its social security reserves for E3 billion to meet its liquidity needs---this by the way is the same fund invested in........drum roll....Spanish bonds.  Any bets on the odds of more riots?
            More analysis:

            A close look at what is occurring in Spain (medium/long):

            More analysis from the Telegraph’s Ambrose Evans-Pritchard (medium):

            The current German position (medium):

            The EU’s false narrative (medium):

            Berlusconi is back (short):

Bottom line: stocks overvalued (as defined by our Model); but investors just keep drinking the Kool Aid.  It seemed like reality was raising its ugly head on Wednesday.  But then yesterday in the face of data pointing to an economy that could be going into stall speed, the focus was on more money printing and another Walt Disney fairy tale out of the EU. 

Don’t get me wrong, our Portfolios are positioned for more money printing (GLD and foreign ETF’s); so that is great for Our Money.  But I hate betting money on a scenario that will lead to destructive inflation.

As for Europe, our forecast is that it will ‘muddle through’.  But implicit in that assumption is that ‘muddling through’ will be a long, painful process that will avoid catastrophe while inching toward fiscal responsibility.  Yesterday’s announced Spanish austerity plan doesn’t move toward fiscal responsibility because it is not mathematically honest.  To be sure, the ‘muddle through’ scenario will prevail as long as investors give these lying bastards a pass; my concern is what happens when, as and if the markets cease believing the bulls**t.

       Investing for Survival

            Dealing with potential food inflation (medium):

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. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.