Saturday, March 1, 2014

The Closing Bell

The Closing Bell

3/1//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%

   Current Market Forecast
           
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Trading Range                     15330-16601
Intermediate Uptrend                              14696-16601
Long Term Uptrend                                 5050-17400
                                               
                        2013    Year End Fair Value                                   11590-11610

                    2014    Year End Fair Value                                   11800-12000                                          

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Trading Range                          1746-1858 (?)
                                    Intermediate Term Uptrend                        1716-2496
                                    Long Term Uptrend                                    728-1910
                                                           
                        2013    Year End Fair Value                                    1430-1450

                        2014   Year End Fair Value                                     1470-1490         

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                          43%
            High Yield Portfolio                                     46%
            Aggressive Growth Portfolio                        46%

Economics/Politics
           
The economy is a modest positive for Your Money.   It was another slow week for economic data---which was sub-par again: positives---January new home sales and the November Case Shiller home price index, Chicago PMI, the Kansas City Fed manufacturing index; negatives---weekly mortgage and purchase applications, February consumer confidence, weekly jobless claims,  the January Chicago National Activity Index, the January Market flash PMI, the February Dallas and Richmond Fed manufacturing indices and the revised fourth quarter GDP and price index; neutral---weekly retail sales, January/December revisions of durable goods orders, February consumer sentiment and January pending home sales. 

The standout stats this week were:

(1)   the bevy of reports on the manufacturing sector, the majority of which were negative.  As you know, industry is one of the big four economic sectors; so clearly these number represent at extension of lousy data flow of late and keep the risk of a slowdown front and center,


(2)   the surprisingly strong January new home sales figure.  As I noted Thursday, January is seasonally a slow month in housing so it is easy to get an unrepresentative stat.  Further, new home sales are about one tenth of existing home sales making them somewhat less important.  And finally, this report comes on the heels of a multitude of terrible housing related numbers from last week. 

Still, good news is good news until proven otherwise.  So I choose to view this as a bright spot in an unsettling, partially weather related data flow not too different from other temporary slowdowns that we have experienced in the current recovery. 

The question remains, how much these lousy numbers are being impacted by the weather and how much by other domestic and international factors?  The answer is that we just don’t know.  So while the warning light continues to flash, our outlook remains:

‘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 is awash in cheap, clean burning natural gas.... In addition to making home heating more affordable, low cost, abundant energy serves to draw those manufacturers back to the US who are facing rising foreign labor costs and relying on energy resources that carry negative political risks.


       The negatives:

(1)   a vulnerable global banking system.  When I checked the overnight news on Wednesday morning, these were among the lead headlines:

BofA estimates possible legal liability of $6.1 billion.

GE to pay $1.7 billion to Japan’s Shinsei bank to end refund liability.

Credit Suisse distances top management from tax dodging claims.

Morgan Stanley and SEC in proposed $275 million settlement of MBS probe.

And yet no individual has been fined, lost his job or is in jail---oh, I forgot.  Four bankers have committed suicide in the last month.

More price fixing (medium):

When the financial sector gets too big (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.  Two items this week:

[a] the house is working on a tax reform package which by and large should be views as a positive,  However, given that this is an election year {i} one has to suspect that part of this is for show, because {ii} much of the ruling class and the media deemed it DOA,

[b] Secretary Hagel is proposing major cuts in military personnel as well as benefits to those who won’t be cut.  Let me stipulate that the US has proven beyond a shadow of a doubt that it is incapable of nation building in non-Western cultures.  Therefore, I am happy to dispense with that part of a standing army whose mission is occupation.  However, we live in a dangerous world made more so by the constant drawing of lines in the sand and stern warning for which there is no backbone to enforce.  So cutting our army to pre-WWII levels seems a bit dangerous to me.

Furthermore, at a time when the administration wants to upgrade the life styles of every minority group in this country, it seems foolishly punitive to me to degrade the life style of the 1% of the country that is defending the 99%.

(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. 

Yellen testified before the senate this week and didn’t change the script from her house presentation.  She did go off message just a tad, referring to rough winter and allowing that it could be having an impact on the economy.  However, she also suggested that it would not temper the Fed’s near term tapering policy.  I don’t have to tell you that I consider that good news.

In addition, she deferred any specifics on the new forward guidance---which is nothing new; but market participants can haul it out as an excuse to bang stocks if they want. 

That leaves us with a Fed attempting to do something that it has never done before---transition to normality without bungling the process.  That said, as you know, I am less concerned about a negative impact of any transition process on the economy [since the ever expanding QE had so little effect] and mostly worried about the Market reaction [since that is where QE exerted its most influence].

       And:

(5)   a blow up in the Middle East or someplace else.  The world has become much more politically volatile in the past six months.  While the turmoil in the Middle East captured the early attention, it is now a global disease.  The most recent hotspot in Ukraine.  There I am less worried about what happens internally or any economic impact outside its borders than I am about Obama and Kerry shooting the mouths off and Putin deciding to stick up their ass.

***after the Market close yesterday and it had become clear that some sort of Russian appearance was occurring in the Crimean portion of Ukraine, Obama took to the air and expressed what I thought were very light weight concerns about the ongoing events in Ukraine.  That likely gives Putin room to do what he wants but keeps the US more or less on the sidelines and away from a position of losing face in some unwinnable showdown.

(6)   finally, the sovereign and bank debt crisis in Europe and around the globe.  It was a generally quiet week for international economic data.  China’s credit problems remains at the forefront of concerns, although deflation in the EU is not far behind.  So far everyone has kept their heads above water but the highly leveraged nature of EU, Chinese and Japanese banking systems along with the low quality of the assets that are leveraged keeps this risk high on my list of worries.

           And:

Bottom line:  the economic data improved just slightly this week, but clearly uncertainty continues to surround our forecast.  The biggest question remains the impact of weather on the numbers; and with the NE suffering another major storm this week, it will be a while before we have any clarity.  I am staying with our forecast for the moment partially due to this weather issue and partly due to the fact that American business has overcome much in the last five years and it has been a mistake to underestimate its ability to adapt and move forward.  Nonetheless, the warning light is flashing.          

Fed tapering policy received another affirmation this week with Yellen’s senate testimony---though as near as I can tell the Market either doesn’t believe her or thinks that tapering won’t impact stock prices.  On the other hand, she did nothing to lift the veil on the coming changes in forward guidance---but again no one seemed to care.

Meanwhile, Yellen is stuck with a Herculean task of unwinding QE without causing economic disruptions. If she is more dovish than Bernanke and tapers or reverses the taper as a result of the poor economic stats, then she will just dig a bigger hole for the Fed to climb out of.  If not, history is still not on her side, i.e. the Fed has never successfully transitioned to tight money.  And that ignores the possibility that the Markets will get sick and tired of tapering for pussies and take matters into their own hands.

The only economic news out of Europe was French unemployment hitting a new high and speculation the Rome will go toes up---so the concerns over the EU economy remain.  The rest of the world wasn’t any better.  Ukraine is a hot spot though more for political than economic reasons.  China holds center stage right now as it appears that the central bank is intent on curbing excess speculation (Janet are you watching?).  Whether this marks the beginning a global unwind of the carry trade remains to be seen.  However, at the moment we know that the Bank of China has managed to prevent a crisis.  So I am leaving the ‘muddle through’ scenario in place though, like the US, the yellow light is flashing.


This week’s data:

(1)                                  housing: weekly mortgage applications and purchase applications fell--again; January new home sales were extraordinarily positive while pending home sales were flat; the November Case Shiller Home Price Index rose,

(2)                                  consumer:  weekly retail sales were mixed; February consumer confidence declined while consumer sentiment rose; weekly jobless claims were worse than consensus,

(3)                                  industry: the January Chicago National Activity Index fell and December reading was revised down; February Chicago PMI was better than estimates; the February Market flash PMI was well below expectations; the February Dallas and Richmond Feds’ manufacturing indices were disappointing while the Kansas City Fed’s index was above consensus; January durable goods orders were better than anticipated though the December revision was worse,

(4)                                  macroeconomic: revised fourth quarter GDP was below estimates while the price index was above.

The Market-Disciplined Investing
           
  Technical

`           The indices (DJIA 16321, S&P 1859) had a good week, especially for the S&P which busted through the upper boundary of its short term trading range (also its all-time high) and now is in the midst of our time and distance discipline affirming that break.  Confirmation will be depend on the S&P remaining above 1848 through the close on next Wednesday (time) or trading above 1885 whichever comes first.  Even if the short term trend is re-set to an uptrend, the S&P will still be out of sync with the Dow; so the Market as a whole will remain trendless.  It continues to trade within intermediate term (1723-2503) and long term uptrends (739-1910).

The Dow closed the week within short (15330-16601) and intermediate term (14696-16601) trading ranges and a long term uptrend (5050-17400).

Volume picked up slightly on Friday; breadth was mixed.  The VIX was down, ending within its short term trading range and intermediate term downtrend and slightly below its 50 day moving average.

The long Treasury was up fractionally.  Having negated the head and shoulders pattern on Thursday’s close, it remained within a short term trading range and an intermediate term downtrend. 

GLD traded down, but remains above the lower boundary of that very short term uptrend and its 50 day moving average.  It finished within both a short and intermediate term downtrend.  I continue to wait for a serious (and unsuccessful) challenge to the lower boundary of its very short term uptrend before getting jiggy about GLD.

Bottom line:  the bulls are still control.  Despite a week full of lousy economic numbers both here and abroad, Yellen reiterating that tapering was still on, a sinking yuan and stampede out of yuan carry trade and escalating tensions in Ukraine, investors not only bid prices up but pushed the S&P through its all-time high.  True, volume was unimpressive, breadth middling and our internal indicator unsupportive.  Plus a successful break by the S&P is not being confirmed by the Dow which leaves the Market trendless. 

 But as I said time and again, price is truth and right now, the truth is smokin’.  So an assault on the upper boundaries of the Averages long term uptrends is becoming ever more likely.

Meanwhile, we have a Market that will either remain in a trading range or become trendless; so there is really not much to do save using any price strength that pushes one of our stocks into its Sell Half Range and to act accordingly.

                For the bulls (medium):

            Technical thoughts from Citi (medium):

                And:

   Fundamental-A Dividend Growth Investment Strategy

The DJIA (16321) finished this week about 39.7% above Fair Value (11675) while the S&P (1859) closed 28.2% overvalued (1449).  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.

The dataflow, especially in the primary sectors of the economy, continues to be sub-par---this week the industrial sector was in the spot light.  I accept that weather is at least partly to blame; but there could be much more at work.  So the lousy numbers can’t be summarily dismissed.  I believe that any real hint that the US is entering a recession would not be well received by the Market.  So the warning light is flashing yellow.

Yellen reiterated that tapering for pussies would remain on go.  As you know, I have my doubts that there will be much economic impact.  Rather I believe that it will largely show up in asset prices. Given this week’s pin action, clearly either no one believes Yellen or no one agrees with my take.  Only time will tell.

The ruling class was relatively quiet this week.  Tax reform was put on the table and if enacted would be a huge plus for the economy and the Market.  But this is an election year and transformational legislation doesn’t usually occur in those years.  Indeed most of the pundits opine that its odds of passage this year are zilch.  It appears that defense spending will take a big hit in the upcoming budget.  If it is not offset by more entitlement spending that is a positive near term.  Longer term, I worry about the wisdom of this action in an increasingly turbulent world. 

Finally, it is not from the EU or the Middle East that the Market could potentially get heartburn.  Rather it is (1) China if its attempt to curb speculation [raising interest rates and weakening the yuan] spills over into the global markets and (2) Ukraine, if investors get the willies over potential armed confrontation.  The former being by far the greater risk, in my opinion.

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.  Indeed, the problem is that any revision in the economic outlook from here is more likely to be negative than positive.

Bottom line: the assumptions in our Economic Model haven’t changed, though the risks are rising that they might.

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.
            
DJIA                                                   S&P

Current 2014 Year End Fair Value*              11900                                                  1480
Fair Value as of 3/31/14                                  11675                                                  1449
Close this week                                               16321                                                  1859

Over Valuation vs. 3/31 Close
              5% overvalued                                12258                                                    1521
            10% overvalued                                12842                                                   1593 
            15% overvalued                                13426                                                    1666
            20% overvalued                                14010                                                    1738   
            25% overvalued                                  14593                                                  1811   
            30% overvalued                                  15177                                                  1883
            35% overvalued                                  15761                                                  1956
            40% overvalued                                  16345                                                  2028
            45%overvalued                                   16928                                                  2101

Under Valuation vs. 3/31 Close
            5% undervalued                             11091                                                      1376
10%undervalued                            10507                                                       1304   
15%undervalued                             9923                                                    1231

* 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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