The Closing Bell
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
2.2%
Inflation
(revised): 1.8 %
Growth
in Corporate Profits: 16.1%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 1.5-2.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 14190-15550
Intermediate Uptrend 14335-19335
Long Term Trading Range 4918-17000
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 1576-1687
Intermediate
Term Uptrend 1521-2109
Long
Term Trading Range 715-1800
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 42%
High
Yield Portfolio 44%
Aggressive
Growth Portfolio 43%
Economics/Politics
The
economy is a modest positive for Your Money. The
economic datapoints this week were light and evenly mixed with no real bias:
positives---weekly retail sales as well as June chain store sales, May consumer
credit, June wholesale sales and the June fiscal budget; negatives---weekly mortgage
and purchase applications, weekly jobless claims, May small business optimism,
wholesale inventories, June consumer sentiment and June PPI; neutral---none.
So the overall
trend in the numbers remains pointed at continued growth in the economy albeit
at a sluggish pace. I am leaving the
amber light flashing because of the confusion over Fed policy (see below)
created this week by Bernanke’s seeming reversal of ‘tapering’. As I noted in Thursday Morning Call, the Fed
may be more confused than investors over what its policy is and/or should
be---which is not a good antidote to economic uncertainty. As a result, businesses and consumers are
likely to remain very cautious---which could contribute to weakness in those
sectors of the economy; hence the warning light. 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 historic inability of
the Fed to properly time the reversal of a vastly over expansive monetary policy.
The
pluses:
(1)
our improving energy picture. The US
The
negatives:
(1)
a vulnerable global banking system. The bad news is that economic/political
conditions continue to deteriorate in southern Europe [Greece ,
Italy , Spain ,
Portugal ]. Given the heavy exposure of those countries’
banking systems to their respective sovereign debts added to the recent
revelations in Italy
that it too [Greece ]
could likely experience substantial derivative losses, this problem remains
front and center as a major source of risk to the global economy.
The good news
is that [a] the Treasury has proposed rules that would punish reckless banker
behavior under criminal law, [b] the FDIC has proposed raising minimum bank
capital requirements to 5% and [c] the Senate has introduced a bill re-instating
Glass Steagall.
To be sure, the
existing risks in the EU banking system far outweigh the positives of a bunch
of yet-to-be-enacted-proposals here at home.
Nevertheless, I will still embrace potential good news just was I do
prospective bad news. So I have to rate
the recent developments in the US
as a plus.
‘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. While
our ruling class continues to fiddle while our spending and taxing policies act
as a drag on the economy, there are still developments about which to be
encouraged---even if they are occurring largely by default. One such point is the Federal deficit. It is narrowing as a result of the enforced
sequester and the expiration of Bush tax cuts.
Our politicians whined, belly ached and prophesied doom when these
measures went into effect. But today,
the economy continues to grow while spending and the deficit as a percentage of
GDP are falling---which in turn serves to
lessen the fiscal drag on the economy.
That’s good.
Another
positive is the collapse of the implementation efforts for Obamacare. Most
people with a lick of common sense strongly believed that this fiscal
monstrosity was never going to work because, as Nancy Pelosi so presciently
observed, no one had any idea what was in the legislation when it passed. Now that we know that it is not going to
work, one provision after another is being delayed or postponed; and that means
that the fiscal drag from this nifty bit of unworkable, ideological dreamscape
puffery is also being delayed and postponed.
To be sure, the
uncertainty that it created is still there and will remain until this piece of
crap is repealed or substantially altered; and that will likely continue to
restrain enthusiasm for investment and consumption. However, the immediate costs that everyone
feared have been delayed at worse for a year or so and at best forever.
All that said,
entitlement and tax reform remain a wet dream at least until after the 2014 elections. That leaves the economy struggling to
overcome a fiscal policy headwind and the Fed assuming that it alone must bear
the responsibility of keeping the economy from falling back into recession---an
assumption that has led to policy moves more harmful than helpful [see a
discussion of this week’s Fed circus below].
I also continue
to worry about .....the potential rise in
interest rates and its impact on the
fiscal budget. As I have noted
previously, the US
So 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 an 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 if 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 .....
(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 headline
this week was, of course, Bernanke’s seeming retreat from his ‘tapering’
comments---‘seeming’ being the operative word.
Pundits disagree about whether he really and truly backed off of the
circa September start date. They are
also going to great lengths to distinguish between ‘tapering’ [implying that it
is the relatively harmless reduction of Fed Treasury and mortgage purchases]
and tightening which they define as raising interest rates [implying that it
will have a meaningful impact on the economy].
Their point being that ‘tapering’ could still could occur near term but
tightening is nowhere to be seen.
First let me
say that the events of this week confirm in spades my central thesis on the
Fed, to wit, 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.
If the recent sideshow hasn’t reinforced the proven inept at portion of that
statement, I don’t what else could.
Let’s recap: in
late May, Bernanke presents ‘tapering’ to the Markets [a step I agree
with]. Then the Markets throw a hissy
fit. Immediately, one Fed official after
another starts walking back Ben’s statement; and when that doesn’t seem to be
working, Bernanke has to come out with his ‘just kidding’ mea culpa. In other words, the Fed either has no clue
what it is doing or it has no confidence in what it is doing. Whichever is the case, ‘inept’ comes to mind.
This whole
episode raises a second issue: who the f**k is in charge of monetary
policy? The Fed or the Market---because
if it is the latter, what do we need Bernanke for?
Finally, all
the fine tuning parsing of ‘tapering’ [not raising rates] versus tightening [raising
rates] is a meaningless exercise.
[a] if the Fed
stops buying $45/$55/$35 billion {you pick the number} in Treasuries a month,
somebody else has to buy them. Those
investors will most likely be a bit more discerning about what they pay than
the Fed; and that probably means higher rates.
If you don’t believe that, go back and look on what happened in the last
month,
[b] the parsers
define ‘raising rates’ as the Fed moving up the Fed Funds rate {at its option}. Of course, that has nothing to do with long
term rates---which have already moved up and nothing is stopping them from
going even higher---or even some short term rates like credit cards. More to the point, as I noted above, once
investors know that the Fed is starting to reverse this massively irresponsible
expansion of reserves {‘tapering’}, I believe rates all along the interest rate
curve could rise substantially. In fact, historically, more often than not Markets
generally lead and at times force changes in Fed policy. If that holds true this time around, it won’t
be the Fed’s choice when to tighten {raise rates}; it will be the Market’s.
Bottom line: my
thesis remains that when Bernanke introduced the notion of ‘tapering’, he
slapped the Markets in the face with a dose of reality. In their gut, investors knew that the Fed had
heavily spiked a massive punch bowl but cheap money [carry trade] was simply
too big a temptation. But when
confronted with reality, they quickly adjusted expectations. So irrespective of his Wednesday afternoon
comment, the genie is now out of the bottle and all the rationalizing in the
world is not going to get back in.
That said, that
thesis is on the cusp of being proven wrong---at least for the time being. But sooner or later, I believe Markets are
going to realize QEInfinity will cease; at a minimum, rates will rise as a
result; at worse, bubbles will be popped and things will not end well.
The latest from
Lance Roberts: the Fed and the liquidity trap (medium):
(4) a blow up in the Middle
East . Egypt
has had the headlines the past two weeks---its importance being as a transit [Suez
Canal ] for Middle East oil. Indeed, oil has moved up as concerns about
the country’s stability have grown---which perfectly illustrates my point: any
disruption in production or transportation of Middle East
oil will negatively impact prices, raising the risk of the US
slipping back into a recession.
(5)
finally, the sovereign and bank debt crisis in Europe . Southern Europe
continues its slide: Greece
needs another bail out, Portugal
is in political crisis over austerity, Spain
is also in crisis over a money-for-influence scandal and first, Italy ,
then France ’s credit
ratings have been downgraded. Finally, in
the latest bit of surreal comedy,
Spanish banks are petitioning the government to allow them to convert their tax
loss carry forwards into capital assets.
Hilarity ensued.
So far, the US
has escaped any major fallout from any of this.
However, my worry is that a political or economic crisis could lead to
financial turmoil that could trigger defaults stemming from excessive sovereign
indebtedness or poor quality, overleveraged bank balance sheets.
‘To be sure, Europe has managed to ‘muddle through’ so
far---indeed that has been our forecast. But if current turmoil in the credit and
derivatives markets continues, the EU economies, in particular those weak Mediterranean
sisters, are much more vulnerable as a result of the magnitude of their indebtedness
and overleveraged banks.’
Bottom line: the US
economy continues to click along although at a historically below average
pace. It is a tribute to American
business acumen that this progress has been made in the face of fiscal,
monetary and international headwinds.
Fiscal policy is
improving although not because our political class is doing anything
responsible. The fiscal restraint on the
economy is lessening as the budget deficit falls; and that is a positive. Further, Obamacare is self imploding and that
is resulting in the delay of new costly and onerous regulations. Now if we could just get these clowns to do
something meaningful, like entitlement and tax reform, fiscal policy could
transition from a negative to a positive.
If fiscal policy
has some bright spots, central bank reserve creation, in particular, our own
central bank monetary policies, keep getting worse. It is bad enough that the Fed clings to a
policy that has done little to improve economic activity or employment while creating
asset bubbles along with lots of rich bankers; but this last week, it folded
like a cheap umbrella when the beneficiaries of its highly spiked punch bowl
threw a temper tantrum. This latest move
reinforces my conviction that the Fed will once again botch any attempt to
transition from easy to tight money.
Finally, Europe
is a mess and it is getting worse. So
far the eurocrats have done what they do best---which is nothing except drink
whisky, smoke cigars and tell each other how smart they are, while occasionally
pontificating on the fiscal and financial problems of the EU and promising that
someday they will do something.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications declined,
(2)
consumer: weekly retail sales rose and June chain store
sales were a plus; May consumer credit jumped substantially; weekly jobless
claims rose versus expectations of a decline; June consumer sentiment fell,
(3)
industry: small business optimism dropped in May;
wholesale inventories declined but sales were quite strong,
(4)
macroeconomic: the minutes from the latest FOMC meeting
were released and they were more dovish than Bernanke’s comments following the
meeting; subsequently in a speech, Bernanke appeared to walk back his original
‘tapering‘ comments; the June budget was in surplus, though there were
technical factors involved; the June PPI came in hotter than anticipated, but
ex food and energy, it was in line.
The Market-Disciplined Investing
Technical
The Averages (DJIA
15464, S&P 1680) had a great week, finishing within striking distance of
their all time highs/upper boundaries of their short term trading ranges
(14190-15550, 1576-1687) and well within their intermediate term (14335-19335,
1521-2109) and long term (4918-17000, 715-1800) uptrends.
Volume on Friday
picked up slightly; breadth was mixed.
The VIX closed below the lower boundary of a very short term
uptrend. If it remains there at the
close Monday, the trend will be broken and that will be a positive for stocks.
GLD traded down;
so it saw no improvement to an already dismal chart.
Bottom line: equities
will likely challenge the 15550/1687 levels next week. If successful, stocks should be off to the
races again. Since they would then be at
all time highs, there exists no overhead resistance. Nevertheless, the upper boundaries of the
three major trends (short term---1750, intermediate term---2109, long term
---1800) will become important benchmarks.
Assuming the
1750/1800 (short and long term upper boundaries) area represents the zone of
maximum upside, that is about 3-6% versus 6% downside if stocks return to the
short term lower boundary, 9% if they slide to the intermediate term lower
boundary, 18% if they return to Fair Value and 57% if they make it all the way
to the long term lower boundary
If the
15550/1687 levels hold, the risk exists that a double, even a triple top will
have been put in.
There is nothing to do but watch the process.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (15464)
finished this week about 34.7% above Fair Value (11475) while the S&P (1680)
closed 18.1% overvalued (1422). 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.
Our economic
growth assumption remains spot on while fiscal policy is improving by default
(declining deficits due to sequestration and tax hikes; and the collapse of
Obamacare). That is enough to sustain my
confidence in our outlook and the assumptions in our Valuation Model.
On the other
hand, we got some reassurance this week that the Fed will most likely screw up
the unwinding of QEInfinity and that leaves the headwinds of either spiking
inflation (if it tightens too slowly) or another recession (if it tightens too
fast) plus the uncertainty of how the stock, student loan, auto loan bubbles
dissipate.
Near term the
issue as it applies to stock prices is how much investor confidence the Fed
retains. As you know, my thesis has been
that the ‘tapering’ talk jarred investors back to reality (QE isn’t going to
infinity and when the Fed starts to tighten, it likely won’t be pretty
economically or with respect to securities prices). I would add that despite the initial
jubilation over Bernanke’s retreat, this latest moved will ultimately serve to
lessen confidence in the Fed---which could make any transition from easy to
tight money even more difficult.
Clearly that
thesis is a short hair away from being debunked. However, it won’t be my first idea that has
proven wrong and it likely won’t be the last.
Nevertheless, even if Markets get suckered again by the Fed, I still
believe that ultimately my thesis will be right.
Finally, bad
news continues to emanate out of Europe ; so the risks of
a sovereign and/or banking debt crisis remain a threat to our ‘muddle through’
scenario.
Bottom line: our main issue today is, is there any changes
warranted in our investment strategy should Fed induced euphoria return and
stocks shoot the moon? Or less
dramatically put, what happens if stocks break out to the upside, driven as it
were by more punch?
(1)
our Valuation Model hasn’t changed, so neither have the
Fair Value of the stocks in our Portfolios.
To be sure, we have a few names on our Buy Lists. But our Portfolios already own full positions
in most. I am going to leave the
remainder at less than full positions because of the simple risk/reward
equation that I cited above. But for an
investor that just has to put money to work, use our Buy Lists,
(2)
if any of our stocks trade into their Sell
Half Ranges
(3)
for anyone wanting to push out on the risk curve: [a]
if 15550/1687 hold and prices roll over, simply buying the VIX (VXX) is a good
alternative as well as the Ranger Short ETF (HDGE) and [b] if stocks rocket
upwards and you have to play, a good multi asset class ETF (IYLD) would be a
less risky way to participate, the Russell 2000 ETF (IWO) would be the more
risky alternative. A purchase of any of
these alternatives should be accompanied by very tight stops.
This week, our Portfolios did nothing.
DJIA S&P
Current 2013 Year End Fair Value*
11600 1440
Fair Value as of 7/31/13 11475 1422
Close this week 15464 1680
Over Valuation vs. 7/31 Close
5% overvalued 12048 1493
10%
overvalued 12622 1564
15%
overvalued 13196 1635
20%
overvalued 13770 1706
25%
overvalued 14343 1777
30%
overvalued 14917 1848
Under Valuation vs.7/31 Close
5%
undervalued 10901 1350
10%undervalued 10327 1279
15%undervalued 9753 1208
* 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.
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